economics 2 - slides 7 - The AD-AS model

What is the output gap?

The difference between effective/observed GDP (Y) and potential GDP (Y_n), i.e., the level at which the labor market is in equilibrium.

What do fluctuations in the output gap represent

business cycle fluctuations

What does an economic expansion phase indicate?

(a) Real GDP is above its trend level,

(b) Growth exceeds trend growth, or

(c) Real GDP is growing.

What is an economic downturn?

A phase during which GDP growth slows down.

What defines a recession?

A phase where real GDP decreases. Some define it as a decrease over two consecutive quarters.

What defines a depression?

A sharp recession, with real GDP falling by at least 10%.

What is a trough in the business cycle?

The lowest point of economic activity during a recession.

What is a peak in the business cycle?

The highest point of economic activity during an expansion.

Give two recent examples of recessions.

The 2008 financial crisis (e.g., US and Belgium) and the COVID-19 pandemic lockdowns.

: Give three examples of depressions.

1) The Great Depression (1930s, US GDP −25%),

2) Russia (1990s),

3) Greece (2008-2013, GDP fell ≥26%).

What does "most economic aggregates vary in synch" mean?

Many indicators (employment, income, consumption, etc.) move with GDP; they are procyclical.

What varies across economic indicators during cycles?

The amplitude/volatility of their fluctuations. E.g., investment and house sales are very volatile.

What does the AS-AD model describe?

It links real GDP (Y) and the aggregate price level (P) through aggregate demand and supply.

How does the AS-AD model treat the time horizon?

A: It focuses explicitly on the short- to medium-run, unlike long-run models.

What does the IS-LM model overlook?

The supply side of the economy.

What is the competition channel in an open economy?

When domestic prices rise (foreign prices constant): exports (X) fall, imports (M) rise, reducing net exports (NX) and thus GDP (Y).

n simple models, how does a change in price level P affect the LM curve?

It shifts the LM curve via the "real money supply" channel.

What is the short-run equilibrium in the AS-AD model?

It occurs at the intersection of the AD and AS curves, representing equilibrium in the goods market at a given price level.

What is meant by "money neutrality"?

In the medium run, a pro-cyclical monetary policy only affects nominal variables, not real ones.

What are contra-cyclical uses of monetary policy?

To cool inflation or to boost the economy when Y≪YnY≪Yn​ by avoiding recession spirals.

Give an example of contra-cyclical monetary policy in practice.

The European sovereign debt crisis (2010–2013) and German reunification responses.

Why do economists disagree on macro policy?

They differ in assumptions about adjustment speed to medium-run equilibrium and the size of the output gap.

What does the Blanchard vs. Summers/Krugman debate highlight?

Disagreements on how large the output gap was in the U.S. post-2021 Biden plan, and fears of overheating.