HEC002 CH2. AD & AS MODEL

define AD

represents the total D in the economy

It also shows real national output demanded at diff/each PL

define D curve

shows the QD (for a part good) at a series of prices

(P on vertical, & Q on horizontal axis)

AD is made up of

C + | + G + (X - M)

descr shape of AD curve

DOWNWARD sloping

Slopes downward to the left, reflecting the neg relo betw PL & National Output

define AD curve

Shows real output purch at each PL

why is AD downward sloping

bc AD = C+I+G + (X - M)

what happens when PL incrs (AD)

g&s expensive so monetary assets lose purch power, thus C decr & AD decr

PL incr so interest rates (cost of borrowing by hholds & firms) incr, thus C&I decr & AD decr

PL incr means incr in price of exports (more expensive). Thus less competitive in overseas markets, net exports decr & AD decr

descr movement along AD curve

A change in PL, ceteris paribus, will lead to a movement along the AD curve

(assuming other things remain constant, ex. holding constant cons, inv & gov spending, & net exports)

factors shifting AD curve

Any ▲s in autonomous factors shifts AD curve

Non-price determinants (C, I, G, (X-M)

incr in C shift AD curve right due to:

> Decr in interest rates

-> Decr in inc tax

-> Incr in transf payments

incr in I shift AD curve right due to:

-> Decr in interest rate

-> Incr in business confidence

-> Incr in inv for later sale

-> Incr in availability of profitable inv opps

incr in (X-M) shift AD curve right due to:

(X incr & M decr)

-> Incr taste & preferences from overseas

-> Easy access to overseas markets

-> Depr of local currency

(appreciation in overseas currency)

-> Local price cheaper compared to overseas prices

other ways of saying factors which shift AD curve

right shift - expansionary FP/MP

the exchange rate weakens (depreciated)/ foreign inc incr expected inflation/ expected profits incr

left shift - contractionary FP/MP

the exchange rate strengthens (appreciated)/ foreign inc decr expected inflation/ expected profits decr

distinguish betw expansionary & contractionary FP

incr gov spending/ decr taxes vs decr gov spending/ incr taxes

distinguish betw expansionary & contractionary MP

incr MS/decr interest rate vs decr MS/incr interest rate

define AS

shows the Q of national output (Y) that all producers are willing to supply at each PL

assumption of AS curve

cost of final output = value added at each stage in prod process

SRAS curve

shows Q of national output that firms are willing to supply at each PL

When SRAS is drawn, we assume other factors are held constant 'ceteris paribus'

(ex. capital stock, nominal wage rates, cost of imported raw materials, tech & productivity)

shape of SRAS curve

UPWARD sloping & has 3 different sections/stages

Section A

(Keynesian range)

Section B

(Intermediate range)

Section C

(Classical range)

descr section A of SRAS curve

FLAT (at very low levels of output) Bc excess capacity, plant & machinery & unemployed workers

(ppc - unemployed resources)

(firms could incr output w/o needing incr in P, can employ more resources to incr prod)

descr section B of SRAS curve

INCRs (approaching full employment level, upward sloping

(ppc - idle resources are now employed)

Existing productive capacity brought into prod = less extra output as dim returns sets in Costs of prod incr, firms less able to incr output at existing PL

descr section C of SRAS curve

STEEP (level of output approaches full capacity)

at greater levels of output, producers have difficulties from delays/bottlenecks in prod & congestion Costs of prod incr

(ppc - full level of employment, hard to incr output more)

movement along AS curve

With no ▲s in wage rates, cost of imported components & state of tech remains unchanged

Any incr in PL = incr in Q of real GDP/movement along the AS curve

impact of incr in AD on SRAS curve

▲s in nominal wage rate

▲s in cost of imported raw materials (resource costs)

(ex. oil prices)

▲s in productivity

▲s in tech

▲s in other factors

(ex. gov regulations/charges/subsidies)

reasons for incr in AS

Nominal wage rate DECR

DECR in price of imported raw materials

Improvement in tech

DECR in GST/other gov charges

(dec. coy. taxes & inc. subsidies)

INCR in productivity

reasons for decr in AS

INCR in nominal wage rates

INCR in costs of imported raw materials

INCR in GST

how change in nominal wage rates affects AS

Incr nominal wage rates = incr cost of prod = decr AS

(incr migration = incr S of labour = decr nominal wage rates = incr AS)

how change in imported raw materials costs affects AS

Incr world P of oil = incr cost of prod = decr prod = decr AS

how change in productivity affects AS

Improved work practices

Incr I

Incr education & training of workers

how change in technology affects AS

Incr tech = incr output = incr AS

how change in other factors affects AS

Factors affecting prod ex. Incr gov charges = decr AS

define LRAS curve

the relo betw the aggregate Q of final g&s (real GDP) supplied & the PL when there's full employment

descr shape of LRAS curve

vertical shape. Independent of PL

3 factors shifting LRAS curve

Labour force (L)

Capital stock (K)

Tech (Te)

These 3 factors shift both SRAS & LRAS curves at same direction

(ex. which shifts both SRAS & LRAS right)

(ex. the larger the labour force, the larger the Q of g&s produced)

explanation for factors shifting LRAS curve

The larger the stock of plant & equipment, the labour force is more productive & the output that it can produce is greater Also larger stock of human capital (skills are acquired thru school & training) More level of output produced

Inventing new & better ways of doing things enables firms to produce more output from any given amount of input

AD/AS equilibrium

EQ where AD = AS

Equilibrium = PLe, Ye

AD>AS (PL1)

=unplanned RUN-DOWN of stocks of goods

Producers incr output/prod

Incr D, employment incr

Incr PL (bring eco back to EQ)

AD

= unplanned BUILD-UP of stocks of goods

Producers decr output/prod

Decr employment & inc

Decr PL (return eco back to EQ)

AD = AS (PLe)

No need for ▲ inc/level of employment)