Curves

AD curve

price level and real GDP

negative relationship due to:

• wealth effect- higher price levels make products appear more expensive → less consumption spending

• interest rates- higher price levels→ more borrowing→ higher interest rates→ less access to credit= less consumption spending

• open economy effect- trade balance worsens because imports appear cheaper than domestically produced goods

can shift left or right:

• confidence, interest rates, tax/ spending, economic performance of trading partners, exchange rate

LRAS curve

• vertical because potential GDP is independent of price level - it shows the output the economy produces when all resources are fully employed

• can shift left or right because of:

• greater quantity of capital, labor or land

• greater labor/ capital productivity

• technological innovation

SRAS

price level and aggregate supply

• positive slope - increased production = inflationary pressure= higher price levels

• affected by things that affect the whole economy e.g. labor participation rate/ size of labor force/ supply shocks/ quantity of factors of production/ changes to input prices

equilibrium

• long run equiilbrium

• sras, lras and ad intersect → actual output = potential output

• unemployment is 4%

• inflation rate 2-3

• gdp 3.25-3.5%

short run equilibrium

• ad and sras = actual output

long term effect on curves

• all shift right

• population increases- migration etc

• capital increases- new projects and businesses

• aggregate demand increases as economic activity rises

• productivity increases- technology

contractionary and expansionary gap

Keynesian ad/as model

• sras and lras replaced by a curved as line- lras unnecessary because the curve shows the position of the economy (increases in AD during low GDP has a small change in price level/ increases in AD during high GDP has a greater change in price level)

• eventually AS becomes a straight line emulating effects o fan economy at the long run aggregate supply curve

• contractionary and expansionary gap

modelling expansion

1. Equilibrium - AD intersects with SRAS and LRAS at Yp where real output = potential output

2. AD shock → rise in AD → increase production → more employment and income cause Yp to increase to Y1, price levels rise as economy nears full capacity

3. AS shock e.g. new technologies that increase labor productivity→ price level falls as cost of production decreases

modelling contraction

1. Equilibrium - AD intersects with SRAS and LRAS at Yp where real output = potential output

2. AD shock- fall in AD→ cut production→ cyclical unemployment and lower income cause Yp to fall to Y1, price levels to fall from P1 to P2 because of reduced inflationary pressures

3. AS shock→ fall in AS→ higher production costs mean less production cause Yp to fall to Y1, price levels rise from P1 to P2 because of cost push inflation.