Economics 2 - The AD-AS model CHAPTER 4

These vocabulary flashcards cover the core concepts of the AD-AS model, including macroeconomic fluctuations, growth trends, consumption and investment determinants, and the mechanisms of aggregate demand and supply.

Business-cycle

Short-run fluctuations in economic activity that the AD-AS model accounts for.

Growth trend

The long-run evolution of economic activity, referring to the rate at which real economic activity grows over a sufficiently long period of time.

Growth trend formula

An assumption that real GDP grows at a constant rate $\gamma$ between two periods, expressed as $Y_{t+1} = (1 + \gamma)Y_t$.

Output gap ($opg$)

The difference between an economy’s potential GDP ($Y_P$) and effective/observed GDP ($Y$), typically expressed as $opg = \frac{Y - Y_P}{Y_P}$.

Potential GDP ($Y_P$)

The activity level corresponding to the natural unemployment level ($u_n$).

Economic expansion

A phase characterized by real GDP being superior to the trend level, real GDP growth being superior to the growth trend, and positive real GDP growth.

Economic downturn

The phase during which the GDP growth slows down.

Recession

A phase during which the GDP actually decreases, often defined specifically as decreasing over at least two consecutive trimesters.

Depression

A particularly sharp recession, defined as at least a $10\%$ decrease in real GDP over the considered period.

Trough

The moment where economic activity reaches its lowest point during a recession phase.

Peak

The moment where economic activity reaches its highest point during an economic expansion phase.

Procyclical variables

Economic variables that tend to vary in the same direction as the GDP, such as employment, household income, private consumption, and firms’ investment.

Contracyclical variables

Economic variables that tend to vary in the opposite direction to the GDP, specifically unemployment and public deficit.

AD-AS model

An aggregate demand and supply model describing the link between an economy’s production of goods and services (real GDP, $Y$) and the aggregate price level ($P$).

Wealth

A stock variable representing the value of a household’s total owned assets minus the value of its liabilities at a specific moment in time.

Income

A flow variable representing the value of resources received or earned by a household during a given period.

Life-cycle theory

A theory used to understand the trade-off between consumption ($C$) and saving ($S$) by considering present disposable income ($Y_D$), wealth, and expected future income ($Y^e$).

Consumption smoothing

The practice where an individual chooses to save or borrow to maintain stable consumption across all periods of life despite income variations.

Precautionary behaviour

A situation where current consumption ($C$) depends negatively on the magnitude of uncertainty affecting expected discounted wealth.

Autonomous consumption ($C_0$)

The part of consumption that does not depend on the household's level of disposable income, capturing factors like wealth and expectations.

Marginal propensity to consume ($c_1$)

The ratio of additional private consumption to additional disposable income, where $0 < c_1 < 1$.

Net expected present value ($NPV^e$)

The criteria for investment profitability, calculated as the expected present value ($PV^e$) minus the total investment cost ($I_t$).

Accelerator effect

The positive impact of real current economic activity ($Y$) on investment ($I$), where higher activity leads to better self-funding or credit access.

Autonomous investment ($I_0$)

The part of investment not correlated with current income or real interest rate levels, influenced by expectations and credit access.

Marginal propensity to import ($m_1$)

A value capturing the sensitivity of imports ($M$) to the current level of economic activity ($Y$).

Price-competitiveness

The relative price level $\frac{P}{P_f}$, which deteriorates when the domestic aggregate price level ($P$) increases faster than the foreign price level ($P_f$).

Interest rate channel

A mechanism where an increase in inflation leads the Central Bank to increase interest rates ($r$), which subsequently decreases aggregate demand ($AD$).

Wage stickiness

The assumption that wages do not increase as fast as the aggregate price level ($P$), causing domestic output to increase along the price level.

Full capacity constraint

A physical limit to output representing the activity level using up all current profitable production capacities.

Full employment constraint

A physical limit to output representing the activity level where all available labor force is mobilised.

Monetary policy

The process by which the central bank or monetary authority manages the money supply to achieve specific goals such as controlling inflation, consumption, growth, and liquidity.

Fiscal policy

Government policy regarding taxation and spending, aimed at influencing economic activity.

Inflation

The rate at which the general level of prices for goods and services rises, eroding purchasing power.

Deflation

A decrease in the general price level of goods and services, often associated with reduced demand.

Stagflation

An economic condition characterized by stagnant growth, high unemployment, and inflation.

Hyperinflation

An extremely high and typically accelerating inflation, often exceeding 50% per month.

Monetary base

The total amount of a currency in circulation or in the commercial banks' reserves.

Public debt

The total amount of money that a government owes to creditors.

Mortgage-backed securities

Asset-backed securities that are secured by a mortgage or a collection of mortgages.

Crowding out

A situation where increased public sector spending reduces or eliminates private sector investment.

Balance of payments

A record of all economic transactions between residents of a country and the rest of the world.

Gini coefficient

A measure of income inequality within a population, ranging from 0 (perfect equality) to 1 (perfect inequality).

Purchasing power parity (PPP)

An economic theory that compares different countries' currencies through a market 'basket of goods' approach.

Exchange rate

The value of one currency for the purpose of conversion to another.

Stocks

Securities that represent an ownership share in a company.

Bonds

Debt securities that represent a loan made by an investor to a borrower.

Liquidity

The ease with which an asset can be converted into cash without affecting its market price.

Capital market

The part of a financial system concerned with raising capital by dealing in shares, bonds, and other long-term investments.

Labor market

The supply and demand for labor, where employees provide the supply and employers provide the demand.

Aggregate demand

The total demand for goods and services within a particular market.

Aggregate supply

The total supply of goods and services that firms in an economy plan to sell during a specific time period.