Classical AD/AS model - Short-run and Long-Run

Classical School of Thought

An economic theory that emphasizes the self-regulating nature of the economy and believes in the long-run aggregate supply being vertical, representing full employment.

Keynesian School of Thought

A macroeconomic theory that advocates for active government intervention in the economy and believes there is no distinction between short-run and long-run aggregate supply.

Short-Run Aggregate Supply (SRAS)

The supply of goods and services in the economy at a certain price level, influenced by fixed costs of production.

Long-Run Aggregate Supply (LRAS)

The supply of goods and services in the economy when all factors of production are used at their full potential, represented as a vertical line at the full employment level.

Deflationary Gap

A situation in which aggregate demand is lower than the economy's full employment output, leading to higher unemployment and lower inflation.

Inflationary Gap

A situation where aggregate demand exceeds the economy's full employment output, causing lower unemployment and increasing inflation.

Adjustment in the Classical Model

In the long run, wages become variable, eventually allowing the economy to return to full employment output without government intervention.

Role of Wages in Short-Run

Wages are fixed in the short run, making it difficult for firms to adjust labor costs during economic fluctuations.

Supply-Side Policies

Economic policies aimed at increasing productivity and efficiency by shifting long-run aggregate supply to the right.

Natural Rate of Unemployment

The long-term rate of unemployment that the economy typically experiences, reflecting frictional and structural unemployment.

Aggregate Demand (AD)

The total demand for goods and services within the economy at a given overall price level.

Self-healing Economy

The classical belief that the economy will naturally return to full employment without government intervention.

Cost of Production

The total expenses incurred by firms in the process of manufacturing goods and providing services, influencing the position of the SRAS.

Equilibrium in Classical Model

Occurs when aggregate demand equals aggregate supply (AD = AS), with both short-run and long-run equilibria defined by the respective curves.