AS/AD & Keynesian Short-Run Policy Model – Core Vocabulary

Vocabulary flashcards summarizing the essential terms, curves, effects, and policy tools from the AS/AD Keynesian Short-Run Policy lecture.

Aggregate Supply–Aggregate Demand (AS/AD) Model

Macro-economic framework that determines the overall price level and real output by intersecting aggregate supply and aggregate demand curves.

Aggregate Demand (AD)

Total planned spending in an economy at each price level, equal to C + I + G + (X – M).

Short-Run Aggregate Demand Curve (AD)

Downward-sloping curve showing the inverse relationship between the price level and the quantity of real output demanded in the short run.

Short-Run Aggregate Supply Curve (SAS)

Upward-sloping curve indicating how much firms are willing to produce at different price levels when some input costs are fixed.

Long-Run Aggregate Supply Curve (LAS)

Vertical line at potential output showing the economy’s maximum sustainable production when wages and prices are fully flexible.

Potential Output

Level of real GDP produced when the economy operates at the ‘target’ or natural rate of unemployment (frictional + structural only).

Target Rate of Unemployment

Unemployment rate consistent with potential output, composed solely of frictional and structural unemployment.

Monetary Policy

Federal Reserve actions that change interest rates and the money supply to influence aggregate demand.

Fiscal Policy

Government decisions on spending and taxation designed to shift aggregate demand.

Expansionary Fiscal Policy

Increase in government spending and/or decrease in taxes intended to shift AD rightward.

Contractionary Fiscal Policy

Decrease in government spending and/or increase in taxes intended to shift AD leftward.

Expansionary Monetary Policy

Federal Reserve action that lowers interest rates, increasing investment and shifting AD rightward.

Contractionary Monetary Policy

Federal Reserve action that raises interest rates, reducing investment and shifting AD leftward.

Paradox of Thrift

Keynesian idea that if everyone tries to save more during a recession, total income falls and overall saving may not increase.

Fallacy of Composition

Error of assuming what is true for an individual is necessarily true for the whole economy.

Interest Rate Effect

Lower price level increases real money balances, reducing interest rates and raising investment, thus increasing quantity of AD.

International (Exchange-Rate) Effect

Lower domestic price level makes exports cheaper and imports costlier, raising net exports and quantity of AD.

Money Wealth Effect

Decrease in price level raises real wealth, boosting consumption and quantity of AD.

Multiplier Effect

Process by which an initial change in expenditures leads to a larger overall change in aggregate demand (Total change ÷ Initial change).

AD Movement

Change in the quantity of aggregate demand caused solely by a change in the price level, shown as movement along the AD curve.

AD Shift

Change in aggregate demand at every price level due to non-price factors, represented by an entire curve shift.

Foreign Income

Income levels abroad; rising foreign income increases U.S. net exports and shifts AD right.

Exchange Rate

Price of domestic currency in terms of foreign currencies; appreciation lowers net exports and shifts AD left.

Distribution of Income

How total income is shared across households; more wages (vs. profits) raises consumption and shifts AD right.

Expectations (Economic)

Outlooks on future economic conditions; optimism shifts AD right, pessimism shifts AD left.

Input Prices

Costs of production inputs such as wages and materials; higher input prices shift the SAS upward (left).

Productivity

Output per unit of input; higher productivity lowers costs, shifting the SAS downward (right).

Recessionary Gap

Situation where short-run equilibrium output is below potential output, generating unemployment pressure.

Inflationary Gap

Situation where short-run equilibrium output exceeds potential output, generating upward price pressure.

Keynesian Prescription

Policy recommendation to use fiscal or monetary stimulus to close recessionary gaps and stabilize output.

Classical (Self-Correcting) View

Belief that flexible prices and wages move SAS so the economy returns to potential output without active policy.

Say’s Law

Classical principle that supply creates its own demand, implying AD will adjust to match potential output.

Financial Panic

Rapid loss of confidence causing asset sell-offs, falling prices, and reduced aggregate demand.

Asset Price Effect

Falling asset values make households feel poorer, reducing consumption and shifting AD left.

Short-Run Equilibrium

Point where the SAS and AD curves intersect, determining the current price level and output.

Long-Run Equilibrium

Condition where SAS, AD, and LAS intersect, with output equal to potential and no pressure for price change.

Feedback Effects

Secondary changes (e.g., falling asset prices, bank stress) that amplify initial shifts in aggregate demand or supply.