Economics Assignment 2
ronifiut
TheAD-ASModelpart3of3.pdf
THE AD – AS MODEL (PART 3 OF 3)
ECO 9740 | Henry
OBJECTIVE
Our discussion will look at the supply side of the AD – AS model
and then look at the AD – AS model
At the end of this lecture, you should understand and be
comfortable with
o the aggregate supply (AS) curve – why it slopes upwards
and what factors will cause it to shift
o using the AD – AS to describe inflationary and necessary
gaps and how the economy can self-adjust eventually
THE AGGREGATE SUPPLY CURVE
Aggregate Supply (AS): shows the relationship between
each possible price level and the quantity of goods and
services that all the nation’s firms are willing to produce
during a specified period of time, holding all other
determinants of aggregate quantity supplied constant
Why does it slope upward?
o input prices (such as wages) are normally fixed for
some period of time
o higher output prices lead to higher production
THE AS CURVE The AS curve and potential GDP (SRAS and LRAS)
P0
AS0 (SRAS0)
Ypot Output (Real GDP)
Price Level (GDPD)
Potential GDP (LRAS)
THE AS CURVE Recall ~
Factors that shift the level of potential output ( shift LRAS)
o changes in the factors of production (labor, land,
capital, natural resources)
Factors that shift the AS curve (SRAS curve)
o nominal wage rate
o prices of other inputs
o technology and productivity
o available supplies of labor and capital
THE AS CURVE The AS curve and potential GDP (SRAS and LRAS)
AS1 (SRAS1)
Y1
P0
AS0 (SRAS0)
Ypot Output (Real GDP)
Price Level (GDPD)
Y2
Potential GDP (LRAS)
AS2 (SRAS2)
THE AD – AS MODEL Equilibrium of Real GDP and the Price Level
P0
AS0 (SRAS0)
Output (Real GDP)
Price Level (GDPD)
Y0
AD0
THE AD – AS MODEL
Inflation and the multiplier ~
o AS is upward sloping
o an increase in AD will increase the price level
THE AD – AS MODEL Equilibrium of Real GDP and the Price Level
P0
AS0 (SRAS0)
Output (Real GDP)
Price Level (GDPD)
Y0
AD0
AD1
Y1 Y
P1
THE AD – AS MODEL
Inflation and the multiplier ~
o AS is upward sloping
o an increase in AD will increase the price level
o higher prices will reduce consumers purchasing power
(and decrease net exports)
o inflation reduces the value of the multiplier suggested
by the oversimplified multiplier (from chapter 9)
THE AD – AS MODEL Long Run Equilibrium
Potential GDP (LRAS)
P0
AS0 (SRAS0)
Output (Real GDP)
Price Level (GDPD)
Y0
AD0
Y0 = Ypot
THE AD – AS MODEL But, what if AD = SRAS at an output level that is not the
potential GDP?
Two scenarios ~
o short run equilibrium with a recessionary gap
o short run equilibrium with an inflationary gap
THE AD – AS MODEL Short Run equilibrium (recessionary gap) ~
o equilibrium GDP is below potential GDP
THE AD – AS MODEL Short Run Equilibrium (recessionary gap)
Potential GDP (LRAS)
P0
AS0 (SRAS0)
Output (Real GDP)
Price Level (GDPD)
Y0
AD0
Ypot
recessionary gap
THE AD – AS MODEL Adjusting to Long Run Equilibrium
Potential GDP (LRAS)
P0
AS0 (SRAS0)
Output (Real GDP)
Price Level (GDPD)
Y0
AD0
Ypot
AS1 (SRAS1)
P1
THE AD – AS MODEL Short Run equilibrium (recessionary gap) ~
o equilibrium GDP is below potential GDP
o the economy experiences unemployment (cyclical) |
actual UE > natural rate of UE
o if nominal wages fall, eventually the SRAS will shift to
the right
real world: nominal wages may not fall ● change in nominal wages is slow and uncertain
o process is really slow ● cyclical UE may linger ● hello
government?
THE AD – AS MODEL
Short Run equilibrium (inflationary gap) ~
o equilibrium GDP is above potential GDP
THE AD – AS MODEL Short Run Equilibrium (inflationary gap)
Potential GDP (LRAS)
P0
AS0 (SRAS0)
Output (Real GDP)
Price Level (GDPD)
Y0
AD0
Ypot
inflationary gap
THE AD – AS MODEL Adjusting to Long Run Equilibrium
Potential GDP (LRAS)
P0
AS0 (SRAS0)
Output (Real GDP)
Price Level (GDPD)
Y0
AD0
Ypot
AS1 (SRAS1)
P1
THE AD – AS MODEL
Short Run equilibrium (inflationary gap) ~
o equilibrium GDP is above potential GDP
o the economy experiences inflation and a short supply of
labor | actual UE < natural rate of UE
o nominal wages increase ● SRAS will shift to the left ●
production costs increases
o both prices and unemployment increases (stagflation) ●
stagflation usually occurs after excessive AD
o an aside: stagflation may also result from a negative supply
shock
THE AD – AS MODEL
Economic Growth~
o real world: price and output grow over time
o AD and SRAS increase over time | increase in population; K,
and/or L; improved technology
o if AD grows slower: slower growth in output ● less inflation
o if AD grows faster: faster growth in output ● more inflation
o supply shocks: higher rates of inflation will be associated
with lower rates of economic growth
o stabilization policy: Employment Act of 1946 ~ the federal
government is responsible for ensuring (pursuing?) the
economic stability of inflation and unemployment
