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Unit 3

3.0 Unit 3 Overview: Production, Cost, and the Perfect Competition Model

4 min readnovember 23, 2021

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Maria Guerra


AP Microeconomics 💵

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Unit 3 Overview: Production, Cost, and the Perfect Competition Model

National Income and Price Determination

Welcome to the bread and butter of macroeconomics! Unit 3 marks the introduction of the Aggregate Model. This model, which looks at ALL of supply and ALL of demand, is like the supply and demand you already know, but on steroids 💪 The good news is you can take your previous knowledge and apply it to Aggregate Supply and Aggregate Demand to make grasping this new information that much easier ✓
Some of my personal favorites in the econ world are multipliers. These simple formulas show us how a small change in spending, savings, or taxes can have a huge 😲 effect on the economy—literally multiplying themselves. Even better, they can help us make sense of the fiscal policies that our government enacts to keep our economy stable (more on fiscal policy later in this unit!). In this unit, we will be looking at both the tax multiplier and the spending multiplier. Here’s a hint to remember: A change in spending will ALWAYS have a greater impact than a change in taxes because of the multiplier! 
One big difference between the basic supply/demand model and the Aggregate Model is the separation of Supply into Short-Run Aggregate Supply (SRAS) and Long-Run Aggregate Supply (LRAS). Having two supply lines changes our equilibrium in this model as well as it requires three curves coming together rather than just two. Look at that awesome star shape it makes! ⭐⭐⭐ But how do we know when the Short Run is and when the Long Run is? Simple! The Short Run is ALWAYS now! And the Long Run . . . well, it’s always in the future. It’s this imaginary place that we can never actively be in! 🤯 Wild, right?
https://firebasestorage.googleapis.com/v0/b/fiveable-92889.appspot.com/o/images%2F-KpOjspVWNrga.png?alt=media&token=040437f8-8a8d-4bef-aa10-a8df7e3f0a63

Image Provided by Fiveable Team

Graphs of the Aggregate Model provide easy visuals that can show us quickly if the economy is in recession or expansion just based on where our lines meet (or don’t meet for that matter). In this unit, you will learn about those stages of disequilibrium and how the economy can move back to equilibrium. Sometimes it happens all on its own (that’s certainly what Adam Smith would prefer 💀) - and that is caused by long-run self-adjustment. When the economy can’t do it on its own, or it’s taking too long, the government 🏛 will step in! 
https://firebasestorage.googleapis.com/v0/b/fiveable-92889.appspot.com/o/images%2F-Jyoe6qvLxopI.png?alt=media&token=a46e1861-0cbe-49c6-9302-ccf8d9f2e995

Image Provided by Fiveable Team

As you can see in these nifty graphs above, the economy can either be in a recessionary gap or an inflationary gap. The recessionary gap is a contracting economy with high unemployment and lower production. It’s not a happy place for the economy 😟.  The inflationary gap, on the other hand, brings with it low unemployment rates and increased production—leading to the dirty “i” word . . . Inflation. But, we already know inflation isn’t the bad guy that everyone makes it out to be. Like most everything else in this world, it is perfectly normal in moderation. While a growing economy is generally a good thing, too much growth and operating beyond equilibrium can cause many other problems. 
It’s not enough to just be able to recognize these situations, however. It’s crucial to take it a step further and understand how the economy will shift back toward equilibrium. More often than not the economy inches back toward equilibrium through the actions of the government—both passively and actively. First and foremost, the government sets up a variety of automatic stabilizers that don’t require the continuous passing of legislation (think unemployment insurance, progressive taxes, and welfare). These government programs kick in as people need them to help prevent constant disruption in our economy. 
However, sometimes these automatic stabilizers just aren't enough and the federal government must take a more active role by adjusting taxes and/or spending. When this happens, we call it Fiscal Policy, and it can lead to some sweeping 🧹 changes in the economy. Understanding these actions within the context of this unit of macroeconomics can truly open your eyes 👀 to the real world of our economy and shed some light 💡 on the policies we hear about on the nightly news. 
And then there’s our good friend—long-run self-adjustment. Here’s an example of an economy moving back to equilibrium without the government’s help: Fiveableville’s economy is in an inflationary gap (expansion) causing unemployment to go down and wages to rise. The increase in wages causes Short-Run Aggregate Supply to decrease because an increase in wages is an increase in the input costs. As the SRAS decreases, the curve will shift to the left bringing it back into equilibrium with Aggregate Demand and the LRAS Curve. Long-run self-adjustment is great, but it takes a lot of time and a lot of patience—something most of us are lacking 😂 ! 

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