02 Nov Self Correction: Recessionary/Inflationary Gap – Economics

If you are curious to try and understand the macroeconomic status we are currently enduring and the pricing mechanisms that theoretically will play out to self-correct – please be entertained by the transcript below…..

The automatic process in which the aggregate market eliminates a recessionary gap created by a short-run equilibrium that is less than full employment through decreases in wages (and other resource prices). The self-correction mechanism is triggered by short-run resource market imbalances that are closed by long-run price flexibility. The self-correction process of the aggregate market also acts to close an inflationary gap with higher wages (and other resource prices).

Self-correction is seen as shifts of the short-run aggregate supply curve caused by changes in wages and other resource prices. The self-correction mechanism acts to close a recessionary gap with lower wages and an increase in the short-run aggregate supply curve.

With an inflationary gap, short-run equilibrium real production is more than full-employment real production, meaning resource markets have deficits.  In particular, labour unemployment is less than the natural rate. Self-correction is the process in which these temporary imbalances are eliminated through flexible prices as the aggregate market achieves long-run equilibrium.

In the long run, wages and resource prices are flexible and they increase enough to eliminate imbalances in the resource markets. The result of increasing wages (and other resource prices) is an increase in production cost. An increase in production cost causes a decrease in short-run aggregate supply to bring supply and demand back into equilibrium.