<p>You indirectly answered your own question when you stated:</p>
<blockquote>
<p>Of course, here I am comparing apples to oranges (somewhat deliberately).</p>
</blockquote>
<p>You are trying to compare something that is incomparable</p>
<ol>
<li><p>Demand shock on individual market <span class="math-container">$\neq$</span> shock to aggregate demand.</p>
<p>For example, <strong>at the same time</strong> when aggregate demand is massively increasing, individual demand at <em>some</em> markets can be collapsing. Even the opposite is possible  while aggregate demand is falling one individual industry might experience boom.</p>
<p>Here anything can happen. If we take market for apples, and assume there was negative <strong>aggregate</strong> demand shock the following could happen to demand for apples:</p>
<ul>
<li><p>demand for apples can decrease</p>
</li>
<li><p>demand for apples can increase</p>
</li>
<li><p>demand for apples can stay constant</p>
</li>
</ul>
<p>Apriori any of the above would be valid scenario even during negative shock to <strong>aggregate</strong> demand.</p>
<p>Aggregate demand is in essence given by (See Blanchard et al Macroeconomics: An European Perspective pp 192):</p>
</li>
</ol>
<p><span class="math-container">$$AD = C+I+G+NX$$</span></p>
<p>where <span class="math-container">$C$</span> is consumption spending <span class="math-container">$I$</span> investment spending, <span class="math-container">$G$</span> government
spending and <span class="math-container">$NX$</span> net export. Aggregate demand can fall because government demand falls <span class="math-container">$G$</span> while at the same time consumer spending <span class="math-container">$C$</span> can increase (just not as much to offset fall in G). Or you could decompose <span class="math-container">$C$</span> into consumer spending for apples, TVs, PCs etc. <span class="math-container">$C= \sum C_i$</span> where <span class="math-container">$i$</span> is any industry you can imagine. Clearly <span class="math-container">$C$</span> can fall even if one component, for example <span class="math-container">$C_{TV}$</span> grows, if just other <span class="math-container">$C_i$</span> fall more than <span class="math-container">$C_{TV}$</span> is growing.</p>
<ol start="2">
<li><p>individual market supply <span class="math-container">$\neq$</span> aggregate supply. Moreover, aggregate supply does not necessarily have the properties that individual supply has - assuming that is fallacy of composition.</p>
<p>The long-run supply is given by the <strong>natural rate of output</strong> or <strong>full-employment output</strong> (see Mankiw Macroeconomics pp 449).  This is not simply sum of all the micro long-run supplies <strong>curves</strong>. It is given by the sum of quantity supplied on all micro markets when <em>macroeconomy</em> (i.e. not necessarily when micro markets are) is in long-run.</p>
</li>
<li><p>Time to reach long-run on individual market <span class="math-container">$\neq$</span> time to reach long-run from macro perspective. Long-run is not some set period of time. In some individual market like in market for ice cream long-run might be few days, whereas in macro long-run will typically take several years or even a decade to reach (prices tend to be sticky).</p>
<p>In microeconomics the long-run is sufficient long time so that firms can enter and exit the market (See Mankiw's Principles of Microeconomics pp 291). In some industries this might be just matter of days.</p>
<p>In macroeconomics the long-run is defined as a sufficient time that all prices (including wages and other things that are prices just with different name) in the economy are fully flexible (see Mankiw Macroeconomics pp 240).</p>
<p>Hence long-run in macro is not the same long-run you will see in micro textbooks. In micro, perfect competition all prices are always fully flexible, so technically there you are always in long-run as defined in macro.</p>
</li>
</ol>
<p>So you are basically comparing things that are not comparable.</p>
<hr />
<p>Now below I will show you my best attempt of representing what happens to aggregate supply and aggregate demand, assuming there is only 1 market in the whole economy, so by definition <span class="math-container">$AD=D$</span>  (otherwise we don't know what happens to <span class="math-container">$D$</span> when there is shock to <span class="math-container">$AD$</span>). And that the single market is perfectly competitive (so price is fully flexible meaning there is <strong>no</strong> short-run AS - short-run AS can only exit if prices are not flexible). Also I plotted example of negative shock.</p>
<p>On a left you can see the micro view (i.e. view you would see in your micro textbook). On right you can see the macro view (i.e. view you would see in macro textbook <strong>if there is only 1 big perfectly competitive market in the whole economy</strong>).</p>
<p>You can see that because prices are fully flexible, in macro box we have <em>only</em> long-run aggregate supply. In the micro side we have both short and long-run.</p>
<p>Aggregate supply is vertical despite that it represent the supply on the market, because aggregate supply is the supply at full employment. With flexible prices and perfect markets economy <em>always</em> works at a full employment. So any time equilibrium on the perfectly competitive market changes the LRAS just shifts to the place given by <span class="math-container">$Q_i$</span>.</p>
<p><a href="https://i.sstatic.net/XRnr0.jpg" rel="nofollow noreferrer"><img src="https://i.sstatic.net/XRnr0.jpg" alt="enter image description here" /></a></p>

CC BY-SA 4.0
2021-12-04T23:02:04.820Z
2021-12-04T23:23:31.367Z
2021-12-04T23:23:31.367Z
1muflon1
<p>In microeconomics, we are taught that in a perfectly competitive industry, the long-run <em>industry</em> supply curve is <em>horizontal</em>. This is because new firms would enter or exit until the profit is driven to zero, at which point the price is equal to the marginal cost. Thus, if there is an <em>industry</em> demand shock, then in the long run, the equilibrium price would remain the same, while the equilibrium output would adjust accordingly.</p>
<p>In macroeconomics, we are taught that in an economy with no factor growth, the long-run <em>aggregate</em> supply curve is <em>vertical</em>. This is because nominal variables have no effect on the economy in the long run, in which the real output depends only on factors of production. Thus, if there is an <em>aggregate</em> demand shock, then in the long run, the equilibrium output would remain the same, while the equilibrium price would adjust accordingly.</p>
<p>Two completely opposite conclusions about the long-run supply curve!</p>
<p>Of course, here I am comparing apples to oranges (somewhat deliberately). In the microeconomic case, we are doing <em>partial</em> equilibrium analysis on a particular industry, while in the macroeconomic case, we are doing <em>general</em> equilibrium analysis on the broad economy.</p>
<p>Nevertheless, we would expect changes in macroeconomic conditions to eventually affect all industries. A macroeconomic shock in aggregate demand should somehow transmit down to the industries. If we combine the two kinds of analysis above, what can we say about how a perfectly competitive industry would respond to an aggregate demand shock in the long run? Would:</p>
<ol>
<li>the equilibrium price remain the same while the equilibrium output adjust accordingly, as said in microeconomic textbooks, or</li>
<li>the equilibrium output remain the same while the equilibrium price adjust accordingly, as said in macroeconomic textbooks, or</li>
<li>both the equilibrium price and output change accordingly?</li>
</ol>

CC BY-SA 4.0
2021-12-01T11:57:59.803Z
The devil is in the details. Is the supply of the inputs used by the industry perfectly elastic (perfectly competitive micro model) or perfectly inelastic (no factor growth macro model)? Thus the essential question is: in what model, with what assumptions do you wish to "*combine the two kinds of analysis above*"?
Giskard
CC BY-SA 4.0
2021-12-01T14:08:26.013Z
@Giskard I didn't have any model in mind when asking this question. Could you write an answer to elaborate on the (possibly several) common models that can combine the two kinds of analysis ?
user141240
CC BY-SA 4.0
2021-12-01T15:28:31.297Z
I make no referrence to any advanced models, I am merely pointing out that the two models you mention make contradictory assumptions, so it is unclear how you want to merge them. If you wish to know what commonly used (where?) models would predict in this scenario, that is IMO a different question than the one above.
Giskard
CC BY-SA 4.0
2021-12-04T21:03:22.963Z
I think an answer to this involves more specificity about the demand shock. Also, if I'm not wrong, aggregate supply is still by industry and at the macro level we deal with international trade by industry. Otherwise, macro level conditions that affect micro-level conditions are financial and handled with monetary policy. If an aggregate demand shock is caused by a currency issue, this may in the very short run only effect prices but in the long run might effect real prices and output. This suggests the further problem specification in time period being considered.
kleinerde
<macroeconomics><microeconomics><general-equilibrium><long-run>
How would a perfectly competitive industry respond to a macroeconomic demand shock in the long run?
user141240
# How would a perfectly competitive industry respond to a macroeconomic demand shock in the long run?

(Asked by: username_0 on 2021-12-01)

In microeconomics, we are taught that in a perfectly competitive industry, the long-run *industry* supply curve is *horizontal*. This is because new firms would enter or exit until the profit is driven to zero, at which point the price is equal to the marginal cost. Thus, if there is an *industry* demand shock, then in the long run, the equilibrium price would remain the same, while the equilibrium output would adjust accordingly.

In macroeconomics, we are taught that in an economy with no factor growth, the long-run *aggregate* supply curve is *vertical*. This is because nominal variables have no effect on the economy in the long run, in which the real output depends only on factors of production. Thus, if there is an *aggregate* demand shock, then in the long run, the equilibrium output would remain the same, while the equilibrium price would adjust accordingly.

Two completely opposite conclusions about the long-run supply curve!

Of course, here I am comparing apples to oranges (somewhat deliberately). In the microeconomic case, we are doing *partial* equilibrium analysis on a particular industry, while in the macroeconomic case, we are doing *general* equilibrium analysis on the broad economy.

Nevertheless, we would expect changes in macroeconomic conditions to eventually affect all industries. A macroeconomic shock in aggregate demand should somehow transmit down to the industries. If we combine the two kinds of analysis above, what can we say about how a perfectly competitive industry would respond to an aggregate demand shock in the long run? Would:

1. the equilibrium price remain the same while the equilibrium output adjust accordingly, as said in microeconomic textbooks, or
2. the equilibrium output remain the same while the equilibrium price adjust accordingly, as said in macroeconomic textbooks, or
3. both the equilibrium price and output change accordingly?

**Tags:** macroeconomics, microeconomics, general-equilibrium, long-run

> **Comments:**
> **username_1**: The devil is in the details. Is the supply of the inputs used by the industry perfectly elastic (perfectly competitive micro model) or perfectly inelastic (no factor growth macro model)? Thus the essential question is: in what model, with what assumptions do you wish to "*combine the two kinds of analysis above*"?  
> **username_0**: @username_1 I didn't have any model in mind when asking this question. Could you write an answer to elaborate on the (possibly several) common models that can combine the two kinds of analysis ?  
> **username_1**: I make no referrence to any advanced models, I am merely pointing out that the two models you mention make contradictory assumptions, so it is unclear how you want to merge them. If you wish to know what commonly used (where?) models would predict in this scenario, that is IMO a different question than the one above.  
> **username_2**: I think an answer to this involves more specificity about the demand shock. Also, if I'm not wrong, aggregate supply is still by industry and at the macro level we deal with international trade by industry. Otherwise, macro level conditions that affect micro-level conditions are financial and handled with monetary policy. If an aggregate demand shock is caused by a currency issue, this may in the very short run only effect prices but in the long run might effect real prices and output. This suggests the further problem specification in time period being considered.  

---

## 1 answers

### Answer by username_3 on 2021-12-04. Score: 2 | Accepted answer

You indirectly answered your own question when you stated:

> Of course, here I am comparing apples to oranges (somewhat deliberately).

You are trying to compare something that is incomparable

1. Demand shock on individual market $\neq$ shock to aggregate demand.

   For example, **at the same time** when aggregate demand is massively increasing, individual demand at *some* markets can be collapsing. Even the opposite is possible while aggregate demand is falling one individual industry might experience boom.

   Here anything can happen. If we take market for apples, and assume there was negative **aggregate** demand shock the following could happen to demand for apples:

   * demand for apples can decrease
   * demand for apples can increase
   * demand for apples can stay constant

   Apriori any of the above would be valid scenario even during negative shock to **aggregate** demand.

   Aggregate demand is in essence given by (See Blanchard et al Macroeconomics: An European Perspective pp 192):

$$AD = C+I+G+NX$$

where $C$ is consumption spending $I$ investment spending, $G$ government
spending and $NX$ net export. Aggregate demand can fall because government demand falls $G$ while at the same time consumer spending $C$ can increase (just not as much to offset fall in G). Or you could decompose $C$ into consumer spending for apples, TVs, PCs etc. $C= \sum C\_i$ where $i$ is any industry you can imagine. Clearly $C$ can fall even if one component, for example $C\_{TV}$ grows, if just other $C\_i$ fall more than $C\_{TV}$ is growing.

2. individual market supply $\neq$ aggregate supply. Moreover, aggregate supply does not necessarily have the properties that individual supply has - assuming that is fallacy of composition.

   The long-run supply is given by the **natural rate of output** or **full-employment output** (see Mankiw Macroeconomics pp 449). This is not simply sum of all the micro long-run supplies **curves**. It is given by the sum of quantity supplied on all micro markets when *macroeconomy* (i.e. not necessarily when micro markets are) is in long-run.
3. Time to reach long-run on individual market $\neq$ time to reach long-run from macro perspective. Long-run is not some set period of time. In some individual market like in market for ice cream long-run might be few days, whereas in macro long-run will typically take several years or even a decade to reach (prices tend to be sticky).

   In microeconomics the long-run is sufficient long time so that firms can enter and exit the market (See Mankiw's Principles of Microeconomics pp 291). In some industries this might be just matter of days.

   In macroeconomics the long-run is defined as a sufficient time that all prices (including wages and other things that are prices just with different name) in the economy are fully flexible (see Mankiw Macroeconomics pp 240).

   Hence long-run in macro is not the same long-run you will see in micro textbooks. In micro, perfect competition all prices are always fully flexible, so technically there you are always in long-run as defined in macro.

So you are basically comparing things that are not comparable.

---

Now below I will show you my best attempt of representing what happens to aggregate supply and aggregate demand, assuming there is only 1 market in the whole economy, so by definition $AD=D$ (otherwise we don't know what happens to $D$ when there is shock to $AD$). And that the single market is perfectly competitive (so price is fully flexible meaning there is **no** short-run AS - short-run AS can only exit if prices are not flexible). Also I plotted example of negative shock.

On a left you can see the micro view (i.e. view you would see in your micro textbook). On right you can see the macro view (i.e. view you would see in macro textbook **if there is only 1 big perfectly competitive market in the whole economy**).

You can see that because prices are fully flexible, in macro box we have *only* long-run aggregate supply. In the micro side we have both short and long-run.

Aggregate supply is vertical despite that it represent the supply on the market, because aggregate supply is the supply at full employment. With flexible prices and perfect markets economy *always* works at a full employment. So any time equilibrium on the perfectly competitive market changes the LRAS just shifts to the place given by $Q\_i$.

[![enter image description here](https://i.sstatic.net/XRnr0.jpg)](https://i.sstatic.net/XRnr0.jpg)


---

