AD-AS Model Test 5 Review

Aggregate Demand (AD)

"Total demand for all goods and services in an economy at various price levels in a given period."

Formula for AD

"AD = C + I + G + (X – M); Consumption + Investment + Government Spending + Net Exports."

AD Curve

"A downward-sloping curve showing the inverse relationship between the overall price level and real GDP demanded."

Wealth Effect

"As price levels fall

Interest Rate Effect

"Lower price levels lead to lower interest rates

Net Export Effect

"Lower domestic prices make exports cheaper and imports more expensive

Shift Right in AD

"Occurs due to factors like increased consumer confidence

Shift Left in AD

"Occurs due to decreased investment

Aggregate Supply (AS)

"Total supply of goods and services firms plan to sell at various price levels in a given period."

SRAS Curve

"Short-run aggregate supply; upward-sloping because input prices (like wages) are sticky."

LRAS Curve

"Long-run aggregate supply; vertical line showing full employment output (Yf)

Why SRAS is Upward Sloping

"Because prices can rise faster than input costs in the short run

Why LRAS is Vertical

"In the long run

Input Prices and SRAS

"Rising input prices shift SRAS left; falling input prices shift it right."

Productivity and SRAS

"Increased productivity or better technology shifts SRAS to the right."

Taxes/Regulation and SRAS

"More taxes or regulation shift SRAS left; less shifts it right."

Supply Shock

"A sudden event (e.g.

Short-Run Equilibrium

"Occurs where AD intersects SRAS; determines current output and price level."

Long-Run Equilibrium

"Occurs where AD = SRAS = LRAS; economy is at full employment and price stability."

Full Employment Output (Yf)

"The economy's potential output when all resources are fully utilized."

Inflationary Gap

"Occurs when Ye > Yf; actual output exceeds potential

Recessionary Gap

"Occurs when Ye < Yf; actual output is below potential

Demand-Pull Inflation

"Inflation caused by increased AD; 'pulls' prices up as demand exceeds supply."

Cost-Push Inflation

"Inflation caused by decreased SRAS; 'pushes' prices up due to rising production costs."

Stagflation

"A situation with rising prices and falling output

Graph of Demand-Pull Inflation

"AD shifts right; SRAS constant; prices and output rise; Ye > Yf."

Graph of Cost-Push Inflation

"SRAS shifts left; AD constant; prices rise

Graph of Recession

"AD shifts left or SRAS shifts left; lower output and price level; Ye < Yf."

Graph of Inflation

"AD shifts right beyond LRAS; temporary rise in output

Long-Run Macroeconomic Problem

"Occurs when economy deviates from LRAS; corrected by wage/price adjustments over time."

Self-Correction Mechanism

"Wages and prices adjust over time to bring SRAS back to full employment level (LRAS)."

SRAS = AD

"Short-run equilibrium; may or may not be at full employment (Yf)."

SRAS = AD = LRAS

"Long-run equilibrium; economy at full employment