L11._The_AD-_AS_Model

What are the two types of shocks in the AD-AS model?

• demand shocks change consumer buying behavior

• supply shocks impact production capacity or costs

What does the LRAS curve represent in the AD-AS model?

The LRAS curve represents the maximum sustainable output of an economy with full resource utilization, shown as a vertical line, indicating that long-term output is unaffected by price levels.

How does a demand shock affect the AD curve?

A demand shock shifts the AD curve right (increased demand) or left (decreased demand), affecting overall output and prices accordingly.

What does a rightward shift in the supply curve indicate?

It indicates that producers can supply more goods at the same price, usually due to higher productivity or favorable policy changes.

What happens to the real wage rate when prices rise in the AD-AS model?

Real wages fall, encouraging firms to hire more workers, as their relative costs decrease.

What is the effect of a recessionary gap in the AD-AS model?

It indicates the economy is underperforming, leading to higher unemployment and lower output, often requiring government action to stimulate growth.

What must happen for a permanent increase in GDP in the AD-AS model?

Improvements in productivity, cuts in unemployment benefits, or lower profit margins to boost hiring.

What does the intersection of AD and LRAS indicate?

Signifies a balanced economy where total demand matches maximum sustainable output.

What will occur if the model is away from full employment equilibrium?

If the economy isn't at full employment, automatic adjustments like price and wage changes will gradually bring it back to equilibrium, though this takes time.

What is the significance of the equation P = Pe in the context of LRAS?

It shows that, in the long run, actual price levels don't affect total production in the economy, which is determined by expected prices. This relationship implies that, in the long run, the economy's output is stable at full employment regardless of the price level, as firms adjust their prices based on expectations.