Macroeconomic Equilibrium

You are expected to explain/analyze (AO2) and draw (AO4) short run equilibrium, neoclassical equilibrium, and Keynesian equilibrium (SL+HL)

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Alternative Views of AS

Short-Run Equilibrium (AO2, AO4)

This diagram is very similar to the microeconomic Supply and Demand graph. Here, though, it is called the AD/AS diagram.

Using the determinants of AD and AS, shifts can also be shown on this diagram, resulting in either increases or decreases in either the general price level or real GDP.

Neoclassical Equilibrium (AO2, AO4)

Equilibrium occurs when the economy is operating at full employment. All lines (LRAS, SRAS, AD) intersect.

This does not mean everyone is working, but rather that the economy is at its natural rate of unemployment (everyone willing and able to work has a job).

Because everything is at full employment, any increase in AD will just result in price increases.

Neoclassicalists believe the model will adjust itself automatically.

Should an inflationary gap exist (A), production prices will increase as there is more demand for products than what can be produced.
This increases the cost of goods and services, raising the price level further, which decreases aggregate demand again (B). Equilibrium is restored, albeit at a higher general price level.
Should a deflationary gap exist (C), production costs will decrease as there is more spare capacity in the economy.
This decreases the cost of goods and services, decreasing price level further, which increases aggregate demand again (D). Equilibrium is restored, albeit at a lower general price level.

Keynesian Equilibrium (AO2, AO4)

Equilibrium can be at any point along AS. Keynesians do not believe in the neoclassical belief of equilibrium adjusting itself automatically to a specific location.

This is because production costs, especially labor, are "sticky downwards" (rarely tend to decrease): Workers rarely accept lower salaries, and it weakens employee productivity.
In this case, production costs will not go down in recessionary gaps, and equilibrium will not correct itself.
Therefore, Keynesians believe strongly in government intervention to correct equilibrium.