Short-Run Equilibrium

Definition

Short-run equilibrium is the point where the quantity of goods and services demanded equals the quantity supplied at a specific price level in the economy. This balance occurs when aggregate demand intersects with short-run aggregate supply, allowing firms to maximize profits based on existing resource constraints. The short-run aspect emphasizes that prices and wages are sticky, meaning they do not adjust immediately to changes in economic conditions.

5 Must Know Facts For Your Next Test

1. In short-run equilibrium, firms produce at a level where marginal cost equals marginal revenue, optimizing their output based on current market conditions.
2. This equilibrium can be disrupted by shifts in aggregate demand or supply, leading to potential short-term fluctuations in price levels and output.
3. Prices in the short run may not reflect changes in the economy due to menu costs or contracts, which can lead to temporary mismatches between supply and demand.
4. The concept of short-run equilibrium is essential for understanding business cycles, as it highlights how economies respond to various shocks and adjustments over time.
5. Transitioning from short-run to long-run equilibrium typically involves adjustments in wages and prices, eventually leading to a new balance where all resources are fully utilized.

Review Questions

• How does the concept of short-run equilibrium help explain fluctuations in economic activity?
  • Short-run equilibrium illustrates how economies react to immediate changes in demand and supply. When there’s an increase in aggregate demand, firms respond by producing more until reaching a new equilibrium. However, if input prices remain sticky, this can create temporary shortages or surpluses, leading to economic fluctuations. Thus, understanding short-run equilibrium is crucial for analyzing business cycles and the immediate impacts of policy changes or external shocks.
• Evaluate the importance of sticky prices and wages in maintaining short-run equilibrium.
  • Sticky prices and wages play a significant role in maintaining short-run equilibrium by preventing immediate adjustments to shifts in demand or supply. When prices do not change quickly due to factors like contracts or menu costs, firms may experience imbalances where demand exceeds supply or vice versa. This stickiness can prolong periods of unemployment or inflation, making it essential for policymakers to understand these dynamics when addressing economic instability.
• Assess how transitioning from short-run equilibrium to long-run equilibrium influences economic stability.
  • The transition from short-run equilibrium to long-run equilibrium is crucial for achieving economic stability as it allows for adjustments in prices and wages. In the long run, all factors of production can adjust, leading to full employment where resources are optimally utilized. This adjustment helps stabilize the economy by eliminating temporary disequilibria caused by shocks or policy changes. As firms adapt by changing their output levels based on new price signals, the economy moves towards sustainable growth and reduced volatility.

Related terms

Aggregate Demand: The total demand for all goods and services in an economy at a given overall price level and in a given time period.

Short-Run Aggregate Supply: The total supply of goods and services that firms are willing and able to produce at a given price level in the short run, when some factors of production are fixed.

Long-Run Equilibrium: The condition in which the economy is operating at full employment, and all resources are fully utilized, leading to stable prices and output over time.