ECON 252 Module 12: Aggregate Demand and Aggregate Supply

AD-AS model

a way to model changes in output (rGDP), inflation (changes in price level), and employment; describes interaction between aggregate demand and aggregate supply in the short run, describes business cycles

AD-AS focuses on

the quantity of output produced across the whole economy (rGDP or Y), the price of that output (PL)

Aggregate demand curve

lower overall price level leads buyers to demand a larger quantity of output

Short run aggregate supply curve

higher overall price level leads to suppliers producing more output

Fed channel

higher price level raises real interest rate, opportunity cost of C and I increases, consumers buy less

Economic forces that contribute to downward sloping aggregate demand

fed channel, international trade effect, wealth effect, debt effect

Aggregate demand shifters/determinants

consumption increases if people feel more prosperous, investment increase if it’s profitable to expand production

A business pricing decision depends on the state of the economy

times of excess demand have higher output which lends to higher prices, leading to upward sloping SRAS

GDP deflator

(nominal GDP/real GDP) * 100

Upward sloping SRAS

prices are sticky, misperceptions theory

SRAS shifters/determinants (SPITE)

subsidies to businesses, productivity, input prices, taxes on businesses, expectations (about inflation)

An increase in AD

increases GDP, increases PL/inflation, decreases unemployment

A decrease in AD

decreases GDP, decreases PL/inflation, increases unemployment

An increase in SRAS

increases GDP, decreases PL/inflation, decreases unemployment

A decrease in SRAS

decreases GDP, increases PL/inflation, increases unemployment

Stagflation

combination of declining GDP and rising prices

Depreciation impact on SRAS

shifts SRAS to the left

Appreciation impact on SRAS

shifts SRAS to the right

Monetary policy

process of setting interest rates in an effort to influence economic conditions

Inflation-induced response

fed cuts interest rates if they’re worried inflation is too law (movement along the AD curve)

Output-induced response

fed cuts interest rate to combat low GDP (shifts AD curve)

Fiscal policy

government’s use of spending and tax policies to influence economic conditions, expansionary fiscal policy shifts AD to right

Change in GDP =

change in spending * multiplier

Multiplier

measure of how much GDP changes as a result of both direct and indirect effects flowing from each extra dollar of spending

GMULT equation

GMULT = 1/MPS

Changes in AD have

a fairly immediate effect

Changes in AS

can take a while to play out

Long run

a period of time long enough that all businesses have had a chance to adjust the prices they charge, tweak the wages they pay, adapt to any price changes from their suppliers/rivals/other businesses

Long-run AS

in the long run, a change in price level has no effect on production, has a vertical curve, aggregate demand is irrelevant to changes in output

Very short AS

horizontal line, prices aren’t flexible in short-run, shifts in AD have big impact on output but not PL

Short run AS

sticky prices, upward-sloping AS curve

Medium run AS

less sticky prices, steeper upward-sloping AS

Why are prices sticky?

contracts, wages, menu costs, misperceptions theory

Recession

Y₁ < Y_p

Long run equilibrium

Y₁ = Y_P

Inflationary gap

Y₁ > Y_p

Shifter/determinant of LRAS

an increase in Y_P, which is growth

Tax multiplier equation

TMULT = -MPC/MPS