Module 11 (AD/AS Model) Flashcards

What are the three key facts about short-run economic fluctuations?

1. They are irregular and unpredictable

2. Most macro variables fluctuate together

3. As output falls, unemployment rises

What is the classical dichotomy?

The idea that real variables (like output) and nominal variables (like money) are separate — in the long run, money doesn’t affect real things.

What is the AD-AS model used for?

To explain short-run economic fluctuations by analyzing interactions between aggregate demand and aggregate supply.

What two variables does the AD-AS model focus on?

• P = Price level (CPI or GDP deflator)

• Y = Real GDP (output of goods and services)

What causes a movement along the AD (Aggregate Demand) curve?

A change in the price level (P)

What does the Long-Run Aggregate Supply (LRAS) curve represent?

The economy’s natural level of output (Yₙ) — full employment output

Why is the Long-run Aggregate Supply (LRAS) curve vertical?

Because price level doesn’t affect long-run output, which depends on resources and technology

What can shift the Long-Run Aggregate Supply (LRAS) curve?

• Changes in labor (population, immigration)

• Capital or human capital

• Natural resources

• Technology

Why is the Short-Run Aggregate Supply (SRAS) curve upward-sloping?

Because in the short run, wages/prices are sticky, and firms respond to changes in the price level.

What are the 3 theories explaining the upward slope of SRAS?

1. Sticky-wage theory

2. Sticky-price theory

3. Misperceptions theory

What causes the Short-Run Aggregate Supply (SRAS) curve to shift?

• Anything that shifts LRAS

• Changes in expected price level (Pᴱ)

What is stagflation?

When output falls and prices rise (SRAS shifts left)

What are two ways policymakers can respond to Short-Run Aggregate Supply shifts?

• Do nothing → let wages/prices adjust

• Use policy (fiscal/monetary) to increase AD

What is a business cycle?

The short-run ups and downs in real GDP and unemployment around the long-run trend

What is the Short-run Aggregate Supply (SRAS) curve?

It shows how much stuff (goods/services) businesses are willing to produce in the short run, depending on the price level.

What does the Short-run Aggregate Supply (SRAS) equation mean: Y = Yₙ + a(P - Pᴱ)?

If actual prices (P) are higher than expected (Pᴱ), businesses make more. If prices are lower than expected, they make less.

What is Yₙ (Y-natural)?

The amount of stuff the economy normally produces when unemployment is normal — full employment output.

What happens if prices turn out higher than expected (P > Pᴱ)?

Businesses make more profit, so they produce more and hire more.

What happens if prices are lower than expected (P < Pᴱ)?

Businesses make less profit, so they cut back production and hiring.

What happens when AD (aggregate demand) shifts left (like in a recession)?

People spend less → GDP drops → prices fall → unemployment rises = recession.

How does the economy fix itself after Aggregate Demand (AD) shifts left?

Over time, wages and expectations adjust → SRAS shifts right → output returns to normal.

What happens when there's a positive demand shock (like exports rising)?

More spending → AD shifts right → output and prices go up → unemployment goes down.

After a demand boom, what happens in the long run?

Wages rise, costs go up → SRAS shifts left → output returns to normal, but prices stay higher.

What causes the Aggregate Demand (AD) curve to shift left or right?

Any change in spending — like taxes, consumer confidence, interest rates, or exports.