Factors that shift the AD curve
Changes in C for a given P
Stock market boom (right) crash (left)
Older workers save more for retirement (left)
Tax hikes left, cuts right, affect dispoableincome
A falls in interest rates increases demand for consumer durables right
A decrases in a expected future income left
Changes in I for a given P
Many firms upgrade their computer sustems at the same time right,
Pessimisitic expecations about future economic performance left
Monetary policy is used to reduce interest rates right
New investment tex credits or other tax incentives right
Changes in G for a given P
Increased deferal spending on deference or infrastruture right
Reduced provincial spending on schools left
Higher municipal spending on roads right
Changes in NX for a given P
Expansions right recessions left in other countries
A new free trade agreement right new trade restrictions left
The AS curves
bThe AS curve shows:
The total quantity of goods and services firms are willing to produce and sell, Y
At any given price level, P
The slope of theAS curve depends on the time horizon
The AS curve is
Close to horzionztonal in the short run
Upward sloping is the medium run
Verical in the long run
The longer the time period, the steeper the AS curve
Note: The economy is in the short run at every point in time
Why the slope of the AS curve matters
If the AS curve is vertical, then
Fluctuations in AD do not causes fluces in output and employment
Prices only changes in the long run
If the AS curve slopes upwards, then
Shifts in AD do not affect output and employment
Prices change less the flatter is the slope of the AS curve
If the AS curve is horz, then
Fluxes in AD affect only output and employment
Prices do not changes
Rationale for differing AS curve slopes
When the AS curve is horz
Prices are sticky
Firms are willing to sell any amount of output at the given price level
When the AS curve slopes upwards
Final goods prices increase more quickly than input prices
Which increases firms' profits
Firms respond by increasing produciton
When the AS curve is vertical
Labout is always fully employed
All prices have fully adjusted
Output is at its potential level whatever the price level
The long-run aggregate supply curve (LRAS)
The long run is not a set amount of time
Rather it is the time required for input prices to adjust fully to economic conditions
When input costs adjust fully to price increases
Firms no longer earn positive economic profits
The economy returns to where it strted
So the LRAS curve is vertical
Potential output (YP) or full-employment output or the natural level of output is the amount of output the economy produces when unemployment is at its natural rate
Why the LRAS curve is vertical
Yp is determined by the economy's
Stock of labour
Stocks of physical and human capital
Stock of natural resources
Level of tech
Y=AF(L,K,H,N)
An increase in P does not affect of these so it does not affect YP.
In the long run, the price level is determined by the quantity of money
Economic Growth: Shifts in the LRAS
Any event that changes any of the determinants of Yp will shift LRAS
Y=AF(L,K,H,N)
Shifts in the LRAS curve represent economic growth and can be described as the very long run
Stock of labour, canada experience annual average output growth of 2.2 over 4 decades.
Analyzing fluctuations in econoimc activity
Causes by events the AD or AS curve shifts
4 steps to analyzing economic fluctations
Dtermine whether the event shifts the AD curve or the AS/LRAS curves
Determine if the curve shifts left or right
Use the AD-AS diagram to see how the shift changes in Y and P in the short run or medium run
Use the AD-AS diagram to see how the economy movse from the temp equilibrium ot the LR equilibrium
For simiplicity, the long run equilibrium will typically be out starting point for analyzing fluctuations in economic activity
Event Stock market crash
Wealth effect: C and AD falls
AD curve shifts left
Inventories rise, Y falls; downward pressure on P
SR equilibrium at B
P and Y are lower
Unemployment is higher
Recession: a period of falling Y and P
Over time, lower P and higher unemployment causes input prices to falls, which shifts the AS right
LR equilibrium moves to C
Y and unemployment return to initial levels
Price falls again
• The results from these exercises apply to any event that shifts AD to the left (right). • The new SR equilibrium (point B) has lower (higher) P and Y, and higher (lower) unemployment. • The fall (rise) in AD causes input prices to fall . • This causes the SRAS curve to shift right (left). → It will continue to do so until the economy returns to potential output (point C) at an even lower (higher) price. • In the absence of policy intervention, the economy “self-corrects”. → The shift in AD is fully reflected in lower (higher) P. • Preview: This process of self-adjustment may take a long time (years) and policymakers/unemployed persons may not want to wait. → Policymakers could use fiscal or monetary policy to shift AD right (left) and move the economy back to the starting point (point A).
• Short-run fluctuations in real GDP are irregular and unpredictable. → Recessions are periods of falling output and rising unemployment. • The AD-AS model is the basic macroeconomic tool for studying the business cycle: fluctuations in output, unemployment, and the price level (inflation rate). • use this tool to: → Understand why the economy deviates from a path of smooth growth over time. → To explore the consequences of government policies intended to reduce unemployment, smooth output fluctuations, and maintain stable prices. • The AD curve shows the relationship between prices and the total demand for goods and services in an economy. → It slopes downward because of the wealth effect, the interest-rate effect, and the exchange-rate effect: a lower price level increases C, I and . → Any change in C, I, G or NX (other than a change in prices) shifts the AD curve
The AS curve shows the relationship between prices and total production. → There are many AS curves: one for the long run, one for the short run, and many for the medium terms. LRAS curve is vertical because changes in the price level do not affect output in the long run. → In the long run, output is determined by labour, capital, natural resources, and technology: changes in any of these will shift the LRAS curve. → Shifts in the LRAS curve represent economic growth. • The upward-sloping AS curves indicate that the prices of final goods adjust more quickly than input prices over time. → These medium-run curves shift in response to anything that shifts the LRAS curve. • The horizontal AS curve indicates that prices are sticky in the short run. • The short- and medium-run AS curves also shift in response to changes in input prices.
Economic fluctuations are caused by demand and supply shocks. • When AD falls, inventories rise, and output and the price level fall in the short run . → Over time, input prices fall and the AS curve shifts right. → Output returns to its potential level and prices fall further. • A temporary adverse supply shock causes output to fall and prices to rise. → As input prices fall over time, the economy recovers. • A permanent supply shock changes prices and output in the long run. • The AD-AS model indicates the possibility of counteracting adverse supply and demand shocks to the economy in the short run by increasing AD. → However, increased spending produces higher prices in the long run
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