Short run in macroeconomics is the period in which the quantity of at least one input is very fixed while the quantity of other inputs varies. In macroeconomic analysis, specifically in the aggregate market analysis, short run is the period when the prices like those of wages are very inflexible and rigid or they are in the process of adjusting. The short run is one of the designations of macroeconomic times.
Short run wages and prices hinder some markets, especially the labor markets from attaining equilibrium. The wage and price inflexibility and the market imbalances that result from short run are the ones that lead to the sloped aggregate supply curve of the short run.
The Aggregate Demand-Aggregate Supply Model (AS –AD)
The (AD- AS) model also called the aggregate demand aggregate supply model is one of the major economic models that explain the output level and the price level relationship with aggregate demand and aggregate supply. The aggregate supply curve measures the total volume of services and goods that are produced within an economy at a given price level. There is a positive connection between aggregate supply and the general price.
High prices point to a signal for businesses to boost their production to meet a very high level of aggregate demand. A rise in the demand of products should lead to an expansion of the aggregate supply in the economy; this means that the demand is affected by supply Shifts in the aggregate supply curve can be brought by factors such as changes in capital stock, technological processes, labor force, taxes and subsidies and inflation expectations.
The aggregate demand curve, on the other hand, illustrates the combination of the price level and output levels in which the goods and the assets are simultaneously held in equilibrium. The slope revealed by the demand curve illustrates the way real balances alter the equilibrium level of spending on assets, and an increase in the real balances leads to a rise in the equilibrium income and the level of spending.
The aggregate demand curve slopes downward because there is an indirect relation between the quantity demanded and the price level of goods or services for real gross domestic product. Changes to the right of the demand curve imply that the quantity demanded goods or services at the same price level has increased, and a shift to the left of the demand curve implies that the quantity demanded has reduced of the real gross domestic product.
The diagram below illustrates the aggregate supply aggregate demand (AS AD) curve
The aggregate demand -aggregate supply (AS-AD) framework can be utilized when explaining the causes of the global financial crisis. One of the major causes of the global financial crisis was diverse innovation in banks financial products. Prior to the commencement of the world economic crisis in the year, 2008, there was the invention of so many financial products, these affected the market of financial products. These products were too many and diverse until they reached a point where the financial products could not be priced correctly. The financial products were also too complex and non transparent. The security industry and financial markets association (SIFMA) estimated that there was 7.4 trillion dollars worth of MBS that were outstanding; this amount was double the amount recorded in the year 2001.
The explosion of these types of securities resulted in the creation of large profit margins for the financial institutions before the financial crisis began. These securities that were not priced correctly, and this made them lose their liquidity when the financial market boom ended. The aggregate demand curve for these securities shifted to the left meaning that the quantity of these securities demanded was low.
The low prices of these financial products meant that the aggregate demand curve of these products shifted to the left. The heavy reliance on these complex financial products in the greatly webbed financial systems resulted in the creation of systemic risk that made the financial sector plunge into a crisis, which affected the economy. This crisis also resulted in slow economic growth for many nations in the world from the year 2009.
The sub-prime mortgages were also another major cause of the financial crisis in the United States. The sub-prime crisis resulted in the putting up of sale of many properties and houses in the United States with very little demand resulting in the shifting of the aggregate supply curve of the properties because of the prediction of a bad economic outlook for the United States.
When the crisis in the housing market triggered many subprime loan defaults, there was a mass exodus from the asset backed money market. The total debts in the US asset backed securities stood at 1.2 trillion in July 2007. When this major source of funding for banks disappeared many banks were forced to transfer the backed assets to their balance sheets. As much as 5 trillion dollars worth of assets were transferred to the bank balance sheets.
The combination of bank write downs of loans on some of the assets, which were held on the balance sheets, and devalued SIV assets resulted in the redoing of the bank capital; this forced many banks to raise interest rates, and reduced the number of loans they offered to other non financial business institutions. The aggregate demand for loans from banks fell as the interest rates increased.