AS-AD Model Flashcards

Aggregate Demand (AD)

• Definition: AD = C + I + G + NX, where:

  • C = Consumer spending

  • I = Investment spending

  • G = Government spending

  • NX = Net exports (Exports - Imports)

• Shifts in AD are caused by changes in:

  • Consumer confidence: Higher confidence leads to increased spending and a rightward shift of the AD curve. Lower confidence leads to decreased spending and a leftward shift.

  • Investment expectations: Optimistic expectations about future profitability increase investment, shifting AD to the right. Pessimistic expectations decrease investment, shifting AD to the left.

  • Government spending/tax policy: Increased government spending or tax cuts increase AD (rightward shift). Decreased government spending or tax increases decrease AD (leftward shift).

  • Net exports: Increased net exports (exports > imports) increase AD (rightward shift). Decreased net exports (exports < imports) decrease AD (leftward shift).

Short-Run Aggregate Supply (SRAS)

• Shifts in SRAS are caused by:

  • Input prices (e.g., wages): Higher input prices (like wages) decrease SRAS (leftward shift). Lower input prices increase SRAS (rightward shift).

  • Expectations of inflation: Higher expected inflation decreases SRAS (leftward shift) as firms anticipate higher costs. Lower expected inflation increases SRAS (rightward shift).

  • Temporary shocks: Adverse supply shocks (e.g., natural disasters, sudden increase in oil prices) decrease SRAS (leftward shift). Positive supply shocks increase SRAS (rightward shift).

Long-Run Aggregate Supply (LRAS)

• LRAS is vertical at the potential output level.

• Shifts in LRAS are caused by:

  • Labor force changes: An increase in the labor force increases LRAS (rightward shift). A decrease in the labor force decreases LRAS (leftward shift).

  • Technology advancements: Technological improvements increase LRAS (rightward shift) by increasing productivity.

  • Capital stock changes: An increase in the capital stock (e.g., more machines, factories) increases LRAS (rightward shift). A decrease in the capital stock decreases LRAS (leftward shift).

  • Natural resources: Discovery of new natural resources increases LRAS (rightward shift). Depletion of natural resources decreases LRAS (leftward shift).

Graph Analysis Tips

• Draw initial equilibrium: Start by drawing the AD, SRAS, and LRAS curves intersecting at the initial equilibrium point.

• Identify which curve shifts: Determine which curve (AD, SRAS, or LRAS) is affected by the given scenario and the direction of the shift (left or right).

• Show new short-run equilibrium: Illustrate the new intersection point of the shifted curve with the unchanged curve(s). This identifies the new short-run equilibrium.

• Show long-run adjustment (if necessary): If the short-run equilibrium is not at the LRAS, show how the SRAS curve will eventually shift to bring the economy back to long-run equilibrium.

• Label changes: Clearly label the changes in:

  • Price Level (P): Increase or decrease

  • Output (Y): Increase or decrease

  • Unemployment (U): Increase or decrease (inverse relationship with output)

Scenario Analysis

The following table outlines the effects of different scenarios on the AD-AS model. FE stands for Full Employment and NR stands for Natural Rate.