Chapter 13 The AD-AS Model Part 2

Vocabulary flashcards covering the components, shifts, short-run and long-run aggregate supply and demand curves, macroeconomic equilibria, and adjustment processes from Chapter 13.

Aggregate Demand ($AD$)

The total demand for final goods and services in the economy, representing planned spending on domestic output at each price level ($AD = C + I + G + NX$).

Aggregate Supply ($AS$)

The total supply of final goods and services produced in an economy, representing the production side.

Components of Aggregate Demand

The four spending categories comprising aggregate demand: Consumption ($C$), Investment ($I$), Government purchases ($G$), and Net Exports ($NX = \text{Exports} - \text{Imports}$).

Aggregate Demand Curve

A curve showing the inverse relationship between the quantity of aggregate demand and the price level, as measured by the GDP deflator.

Wealth Effect

The change in the quantity of aggregate demand that results from wealth changes due to price level changes; an increase in the price level reduces real wealth, causing consumption to decline.

Interest Rate Effect

The change in aggregate demand occurring when an increase in the price level causes real wealth and savings to fall, raising interest rates and elevating borrowing costs, which leads to reduced investment.

International Trade Effect

The change in aggregate demand occurring when a higher domestic price level makes domestic goods relatively more expensive for foreigners and foreign goods relatively cheaper for domestic consumers, resulting in decreased exports and falling net exports ($NX$).

Function of the Firm

The economic framework where a firm uses inputs (labor, capital, raw materials) with input prices (wages, interest rates) to produce output (goods and services) sold at output prices determined by the firm or market.

Long Run (in Macroeconomics)

A period of time sufficient for all input and output prices across the entire economy to fully adjust.

Short Run (in Macroeconomics)

The period of time in which some prices have not yet fully adjusted, leaving nominal wages and certain input prices sticky.

Full-Employment Output ($Y^*$)

The economy's sustainable level of production in the long run, occurring when unemployment is at its natural rate ($u = u^*$) and determined solely by resources, technology, and institutions.

Long-Run Aggregate Supply ($LRAS$) Curve

A vertical curve showing that long-run production is not affected by changes in the overall price level, positioned permanently at full-employment output ($Y^*$).

Shifts in Long-Run Aggregate Supply

Permanent shifts in the economy's productive capacity ($LRAS$) caused by changes in resources (natural resources, human capital, physical capital), technology, or institutions.

Short-Run Aggregate Supply ($SRAS$) Curve

An upward-sloping curve illustrating a positive relationship between the overall price level (GDP deflator) and the quantity of aggregate supply in the short run.

Sticky Input Prices

The sluggish adjustment of nominal wages and other input costs (often fixed by contracts), which temporarily raises profit margins and induces firms to expand production when output prices rise.

Menu Costs

The transaction and administrative costs of changing printed prices, which discourage firms from immediately updating prices and lead them to increase output instead in response to higher demand.

Money Illusion

The tendency of individuals to interpret nominal wage or price changes as real changes, making workers resistant to nominal wage cuts even during economic downturns.

Shifts in Short-Run Aggregate Supply

Shifts of the $SRAS$ curve resulting from changes in resource prices (such as nominal wage adjustments or oil prices) and supply shocks that affect production costs without altering $LRAS$.

Short-Run Equilibrium

The macroeconomic condition occurring where aggregate demand ($AD$) and short-run aggregate supply ($SRAS$) intersect, where real GDP may be above, below, or equal to full-employment output ($Y^*$).

Long-Run Equilibrium

The macroeconomic point where $AD$, $SRAS$, and $LRAS$ intersect simultaneously, meaning real GDP equals full-employment output ($Y^*$) and unemployment equals the natural rate ($u^*$).

Adjustment to an Increase in Aggregate Demand

The process where an initial rightward shift in $AD$ increases price level and real GDP ($Y_1 > Y^*$) while lowering unemployment ($u < u^*$) in the short run, after which rising nominal wages shift $SRAS$ left, returning real GDP to $Y^*$ at a higher price level.

Adjustment to a Decrease in Aggregate Demand

The process where a leftward shift in $AD$ reduces the price level and real GDP ($Y_1 < Y^*$) while raising unemployment ($u > u^*$) in the short run, after which falling nominal wages reduce production costs and shift $SRAS$ right, returning output to $Y^*$ at a lower price level.

Macroeconomic Effect of Technological Progress

A permanent productivity advance that shifts both $LRAS$ and $SRAS$ rightward, resulting in a higher full-employment output ($Y^{**}$), a lower price level, and unemployment remaining at the natural rate ($u = u^*$).

Temporary Supply Shock

An unexpected, short-term disruption (such as a pipeline break or war disrupting oil supply) that temporarily raises resource prices and shifts $SRAS$ left, raising the price level and reducing real GDP ($Y < Y^*$) until the supply recovers.