In all the previous macroeconomic videos, we have been looking at economies which have their price level fixed. Eventually, prices will have to change! Well, in our modern day, the only direction we see prices going is upwards. 🙁 But is it necessarily a bad thing? Not all the time! It may signify strong economic growth!
So why do prices change? It’s the same reason as demand and supply!
Let’s talk about the supply side of the macroeconomic story. Remember that we talked about in microeconomics, the supply curve is the summation of all the marginal cost curves of the firms? This time, the macro version of the supply curve is called the AGGREGATE SUPPLY CURVE. That’s because we add up all the goods and services that the country is able to produce. And what determines how much we produce? You guessed it, COSTS! Therefore, the factors that affect the AS curve are similar to our MC curve: Productivity, labor wages and capital interest rates!
So what about the demand side of macroeconomics? We call that AGGREGATE DEMAND because we are summing up all the demand coming from households, firms, government and even the rest of the world! Therefore, the equilibrium in the ADAS model gives us the GENERAL PRICE LEVEL of the economy!
The moment prices change, we have entered the long run. (In the further units of Macroeconomics, you will learn that we refer to this as only the medium run! Yes, there is a longer damn run.) The reason why monitoring prices is an excellent way of measuring time frame is because prices take time to change. That goes for wages as well!
You will also realize that when prices and wages can change, the economy does not have much of a chance to grow in the long run as well!
At the end of this video, you should be able to:
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