AD and SRAS

ECON 104

what is the aggregate demand (AD) and aggregate supply model (SRAS)

A model that explains short-run fluctuations in real GDP and the price level.

what does the aggregate demand curve show?

shows the relationship between the price level and the quantity of real GDP demanded by households, firms, and the government (both inside and outside the country).

what does the SRAS demand curve show?

shows the relationship in the short run between the price level and the quantity of real GDP supplied by firms.

why is the AD curve downward sloping

because a fall in the price level increases the quantity of real GDP demanded.

what is the wealth effect?

The effect of the price level on consumption is called the wealth effect, and it is one reason the aggregate demand curve is downward sloping.

what happens when prie level rises for consumption?

When the price level rises, the real value of household wealth declines, and so will consumption, thereby reducing the quantity of goods and services demanded.

how does a high price level affect investment?

· A higher price level will increase the interest rate and reduce investment spending, thereby reducing the quantity of goods and services demanded.

how does a low price level affect investment?

A lower price level will decrease the interest rate and increase investment spending, thereby increasing the quantity of goods and services demanded.

what is the interest rate effect

The effect of the price level on investment and consumption is known as the interest-rate effect, and it is a second reason the aggregate demand curve is downward sloping.

what are net exports?

Net exports equals spending by foreign households and firms on goods and services produced in the United States minus spending by U.S. households and firms on goods and services produced in other countries

what happens if the price level rises on net exports

If the price level in the United States rises relative to the price levels in other countries, U.S. exports will become relatively more expensive, and foreign imports will become relatively less expensive.

what happens if price level changes bur other variables go unchanged on the AD curve

If the price level changes but other variables that affect the willingness of households, firms, and the government to spend are unchanged, the result is a movement up or down along a stationary aggregate demand curve.

If any variable other than the price level changes, the aggregate demand curve……….

will shift not move up or down the curve

what variables shift the aggregate demand curve

I. Changes in monetary policy and fiscal policy

2. Changes in the expectations of households and firms

3. Changes in foreign variables

what is monetary policy

The actions the Federal Reserve (nations’ central bank) takes to manage the money supply and interest rates to achieve macroeconomic policy objectives.

what does the federal government use to shift the AD curve

monetary policy and fiscal policy

what is the federal reserve’s goal of using monetary policy

high employment, price stability, high rates of economic growth, and stability of the financial system.

what is fiscal policy

Changes in federal taxes and purchases that are intended to achieve macroeconomic policy objectives.

what happens to the AD curve if taxes decrease?

A decrease in business taxes shifts the aggregate demand curve to the right.

an increase in interest rates will sift the AD curve to the left because?…

higher interest rates raise the cost to households and firms of borrowing, reducing consumption and investment spending.

an increase in government purchases shifts the AD curve to the right because?….

government purchases are a component of aggregate demand. and the more money the government spends on people, the more income they have so consumption increases, therefore increaasng demand

an increase in personal income taxes or business taxes shifts the demand curve to the left because?…..

consumption spending falls when personal taxes rise, and investment falls when business taxes rise

an increase in households expectations of their future incomes will shift the demand curve right because?

consumption spending and the residential investment component of investment spending increase.

an increase in firms' expectations of the future profitability of investment spending shifts the AD curve to the right because

investment spending increases.

an increase in the growth rate of domestic GDP relative to the growth rate of foreign GDP shifts the AD curve to the left because?…

imports will increase faster than exports, reducing net exports.

an increase in the exchange rate (the value of the dollar) relative to

foreign currencies shifts to the left because?

imports will rise and exports will fall, reducing net exports

worst recession since 1930s?

The recession of 2007-2009 was the longest and most severe since the Great Depression of the 1930s.beause it was unsualluy long and deep

what is LRAS (long run aggregate supply)

A curve that shows the relationship in the long run between the price level and the quantity of real GDP supplied.

why is the SRAS curve upward sloping?

because, over the short run, as the price level increases, the quantity of goods and services firms are willing to supply will increase.

why do firms supply more goods and services as price increases?

As prices of final goods and services rise, prices of inputs-such as the wages of workers or the prices of natural resources-rise more slowly. Firms earn higher profits when the prices of goods and services they sell rise more than the prices they pay for inputs.

2. As the price level rises, some firms are slow to adjust their prices. A firm that is slow to raise its prices when the price level is increasing may find its sales increasing and, therefore, will increase production.

why do some firms adjust their prices more slowly than others?

some firms and workers fail to accurately predict changes in the price level. If firms and workers could predict the future price level exactly, the short-run aggregate supply curve would be the same as the long-run aggregate supply curve.

reasons why SRAS is in an upward slope

I. Contracts make some wages and prices "sticky."

2. Firms are often slow to adjust wages.

3. Menu costs make some prices sticky.

what does sticky mean?

Prices or wages are said to be "sticky" when they do not respond quickly to changes in demand or supply. Contracts can make wages or prices sticky.

what happens to firms when they are too slow to adjust wages

If firms are slow to adjust wages, a rise in the price level will increase the profitability of hiring more workers and producing more output.

A fall in the price level will decrease the profitability of hiring more workers and producing more output.

what are menu costs

the costs to firms for changing prices

when will the movement along up or down the curve for SRAS happen

if the price level changes, but other variables remain constant

what variable shifts the SRAS curve?

1. increase in labour force and capital stock

2. technological change

3. changes in expected future price level

4. adjustments of workers and firms to errors in past expectations about the price level

how does increases in capital stock and labour force affect the SRAS curve

So, as the labor force and the capital stock grow, firms will supply more output at every price level, and the short-run aggregate supply curve will shift to the right.

how does the increase in technological change affect the SRAS curve

As positive technological change takes place, the productivity of workers and machinery increases, which means firms can produce more goods and services with the same amount of labor and machinery. This increase in productivity reduces the firms' costs of production and allows them to produce more output at every price level. As a result, the short-run aggregate supply curve shifts to the right.

how does changes in expected future price levels affect the SRAS curve

In general, if workers and firms expect the price level to increase by a certain percentage, the SRAS curve will shift by an equivalent amount, holding constant all other variables that affect the SRAS curve.

how does adjustments of workers and firms to errors in past expectations about the price level affect the SRAS curve

If workers and firms across the economy are adjusting to the price level being higher than expected, the SRAS curve will shift to the left. If they are adjusting to the price level being lower than expected, the SRAS curve will shift to the right.

what is supply shock?

An unexpected event that causes the short-run aggregate supply curve to shift.

how does unexpected changes in the price of a natural resource affect the SRAS curve? (oil shocks)

Rising oil prices lead to rising gasoline prices, which raise transportation costs for many firms. Because firms face rising costs, they will supply the same level of output only if they receive higher prices, and the short-run aggregate supply curve will shift to the left.

what is all production in the economy?

aggregate supply

what is all purchases in the economy

aggregate demand

what does P stand for

GDP Deflator or Price level

what does Real GDP measure ?

measures production, spending and income

what are the components of AD

AD = C + I + G + NX

What is consumption?

spending by households

what is disposable income

income- taxes + transfer payments

different between wealth and income

income is what you earn and wealth is what you own