The Medium Run: The AS-AD Model

Flashcards based on lecture notes covering key concepts of the AS-AD model, Aggregate Demand, Aggregate Supply, and their implications in economic policies.

What does the Aggregate Demand relationship capture?

The effect of the price level on output.

What happens to real money (M/P) when price level (P) decreases?

It increases, enhancing consumption capability.

What is the impact of an increase in M/P on interest rates?

Interest rates decrease.

What factors can shift the Aggregate Demand function?

Fiscal policy changes, monetary policy changes, and changes in consumer confidence.

In the long run, what does aggregate production depend on?

The availability of inputs and technology.

How is the production function expressed in the context of Aggregate Supply?

Y = A F (K, L) where Y is output, A is technology, K is capital, and L is labor.

What is the natural level of unemployment?

It includes frictional and structural unemployment.

What causes cyclical unemployment?

Fluctuations in the economy, such as recessions.

What happens during an expansionary monetary policy?

The money supply (M) is increased.

What is the expected effect of expansionary fiscal policy on Aggregate Demand?

It increases AD by raising government spending (G) and/or decreasing taxes.

What is the result of an unexpected increase in price above expected price (EP)?

Production exceeds the natural level of output.

What did the Great Recession (2008-2010) signal in terms of Aggregate Demand?

Caused by a sharp fall in demand due to a credit crunch leading to severe economic downturn.

What did the Oil Price Crisis (1973-1980) imply for Aggregate Supply?

A negative shock in Aggregate Supply due to high oil prices.

What did developed countries implement during the Oil Price Crisis?

Expansionary fiscal and monetary policies.

In long run, what is the relationship between output and price levels according to the AS-AD model?

Production returns to its natural level (Yn) while prices adjust.