Transcript AD - cloudfront.net

Consumption
Autonomous
consumption- The minimum level of
consumption that would still exist even if a consumer had
absolutely no income. (would occur regardless of a change
in income)
Saving
 Household
 The

NOT spending
ability to save is constrained by
The amount of disposable income
The
 Do
propensity to consume
households save if Yd = 0?
NO
Determinants of C & S
 Wealth- this is not how much money you make it is made
up of savings, assets (stocks and bonds), and real estate
 Increased wealth .: Inc. C & Dec. S
 Decreased wealth .: Dec. C & Inc. S
 Expectations
 Positive .: Inc C & Dec S
 Negative .: Dec C & Inc S
 Household
Debt
 High Debt .: Dec C & Inc S
 Low Debt .: Inc C & Dec S
 Taxes
 Taxes
 Taxes
Inc .: Dec C & Dec S
Dec .: Inc C & Inc S
MPC & MPS

Marginal Propensity to Consume
 ΔC/ΔYd
%

of every extra dollar earned that is spent
C
 Usually

DI by $1
between 0 and 1
Marginal Propensity to Save
 ΔS/ΔYd
%
of every extra dollar earned that is saved

MPC + MPS = 1

1 – MPC = MPS

1 – MPS = MPC
small
larger
_______ changes in spending  _______
changes in income/output
AE = Aggregate Expenditures = C + I + G + Xn = AD
Key Assumptions of the
Spending Multiplier:

The economy supports repetitive, continuous
flows of expenditures and income through which
dollars spent by Smith are received as income by
Chin, then spent by Chin and received as
income by Gonzales, and so on.

Any change in income will cause both
consumption and saving to vary in the same
direction.
Yd  __C and __ S
A larger disposable income means more is available to spend and save.
Investment
+ second-round C
+ third-round
C
+ fourth-round C
= $100
= MPC x $100
= MPC²x $100
= MPC³x $100
Total increase in rGDP= (1+ MPC+ MPC²
+MPC³) x $100
I= {1/(1-MPC)} x $100
Spending Multiplier
Formulas:
M = 1/MPS or 1/1-MPC or GDPE/ AE
If the MPS = .20
.80
5
.25
4
the MPC = ____ M = ____
If the MPC = .75 the MPS = ____ M = ____
.10 M = ____
10
If the MPC = .90 the MPS = ____
If the change in GDPE = $20 billion and the change in AE = $5 billion,
.75 and the MPS = _____.
.25
4 and the MPC = _____
then the multiplier = ____
Key Formula:  AE x M =  GDPE
M = 1/MPS or 1/1-MPC or GDPE/ AE

If the GDP gap is $100 billion, how much must AE (C, I, G, or
Xn) increase to return the economy to YF if the MPC = .80?
5
M = 1/1-MPC = 1/1-.80 = 1/.20 = _____
 AE x M =  GDPE
20
______
X
5
______
= 100 Billion
Key Formula:  AE x M =  GDPE
M = 1/MPS or 1/1-MPC or GDPE/ AE

If the GDP gap is $40 billion and the MPS = .25, what amount must
AE increase to close the GDP gap?
4
M = 1/MPS = 1/.25 = _____
 AE x M =  GDPE
10
4
______
X ______
= 40 Billion
Key Formula:  AE x M =  GDPE
M = 1/MPS or 1/1-MPC or GDPE/ AE

If the economy is in a recession and has a GDP gap of $50 billion,
how much must government increase G to close the GDP gap
and return to full employment, assuming an MPS of .20?
5
M = 1/MPS = 1/.20 = _____
 AE x M =  GDPE
10
5
______
X ______
= 50 Billion
Key Formula:  AE x M =  GDPE
M = 1/MPS or 1/1-MPC or GDPE/ AE
• If actual output exceeds potential output
(YF) by $80 billion, how much must AE
decrease in order to dissipate the
inflationary gap, assuming an MPS of .25?
4
M = 1/MPS = 1/.25 = _____
 AE x M =  GDPE
20
4
______
X ______
= 80 Billion
Does a change in G have
the same effect on GDP as a
No – G has a greater effect!
change in T?
A change in G affects GDP directly by a multiple of the
change in G.
A change in T affects GDP by a multiple of less than the
change in T.
A change in T results in a change in Yd. Yd can be either
spent (C) or saved (S); therefore, a change in T only affects
GDP by a multiple of the change in C. The initial change in
C is less than the change in T.

If

Expectations- when the economy grows then
current and future incomes grow
Permanent 
income
hypothesis 
MPC
multiplier
Current income
future income
savings
savings now

Lifestyle hypothesis- consumers plan their spending
over their lifetime (save during peak years)

Most recessions begin as a decrease in investment
Planned investment spending
Firms
intend to undertake

Interest rate

Expected future level of rGDP

Current level of production capacity
Ex. Homebuilders only build what they think they can
sell and houses are more affordable and more likely to
sell when the interest rate decreases

Firms with investment spending projects will go ahead
only if they expect a rate of return higher than the cost of
funds they would borrow to finance that project

Expected Rates of Return

How does business make investment decisions?


How does business determine the benefits?


Expected rate of return
How does business count the cost?


Cost / Benefit Analysis
Interest costs
How does business determine the amount of investment
they undertake?

Compare expected rate of return to interest cost
 If
expected return > interest cost, then invest
 If
expected return < interest cost, then do not invest
Retained earnings- past profits used to finance I
If a firm has enough capacity to produce it is currently selling at, then it
will spend only to replace existing technologies and equipment and
other structures that wear out or become obsolete
Current level of productive capacity has a negative impact on
investment
Inventory investment- value of change in total inventories held during a
given period (because firms can’t accurately predict sales
Unplanned inventory investment- actual sales are less than business
expected, leading to an unplanned increased in inventories
Actual investment spending- sum of planned investment and
unplanned inventory investment
If there are unplanned inventories leads to a decrease in the following
months production which then leads to a slowing economy
Growth?

5 machines break and replace all 5

5 machines break and replace 2

5 machines break and replace all 5 and add 2 more
Investment Demand Curve
(ID)

What is the shape of the Investment demand curve?


Downward sloping
Why?

When interest rates are high, fewer investments are
profitable; when interest rates are low, more investments
are profitable

Conversely, there are few investments that yield high rates
of return, and many that yield low rates of return
The Investment Demand Curve
irR
Changes in irR cause
changes in IG. Factors
other than irR may shift
the entire ID curve
5%
3%
ID
$2
trillion
$3
trillion
IG
Shifts in Investment Demand (ID)




Cost of Production
 Lower
costs shift ID right
 Higher
costs shift ID left
Business Taxes
 Lower
business taxes shift ID right
 Higher
business taxes shift ID left
Stock of Capital
 If
an economy is low on capital, then ID right
 If
an economy has much capital, then ID left
Expectations
 Positive
expectations shift ID right
 Negative

expectations shift ID left
Technological Change
 New
technology shifts ID right
 Lack
of technological change shifts ID left
Shifts in Investment Demand
irR
When investment demand
shifts, different levels of gross
private investment occur even
while irR remains constant
4%
ID1
ID
$2.5
trillion
$3.25
trillion
IG
Instability of Investment




Durability
 Capital has a long life-span, therefore once it is built there
is no immediate need for further investment
Variability of Profits
 Profitability is subject to the forces of competition, cyclical
changes in the economy, and human management
decisions
Variability of Expectations
 Political, social and natural phenomenon shape our
positive and negative expectations of the future
Irregularity of Innovation
 Innovation does not proceed in a smooth linear fashion,
instead there are bursts of innovation followed by periods
of relative stability
Aggregate Demand (AD)

Define aggregate demand as the total demand
for an economy’s output (production of goods
and services) over a given period of time.

Shows the amount of Real GDP that the private,
public and foreign sector collectively desire to
purchase at each possible price level


Households (consumption), firms (investment), the public sector
(government spending) or foreign households, firms, or governments (net
exports).

YAD = C + I + G + NX
The relationship between PL and rGDP is inverse
PL
Aggregate
Demand Curve
AD
GDPR
The Wealth Effect (P and C )
Suppose P rises.
 The dollars people hold buy fewer g&s,
so real wealth is lower.
 People feel poorer.
Result: C falls.
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
27
The Interest-Rate Effect (P and I )
Suppose P rises.
 Buying g&s requires more dollars.
 To get these dollars, people sell bonds or other
assets.
 This drives up interest rates.
Result: I falls.
(Recall, I depends negatively on interest rates.)
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
28
The Exchange-Rate Effect (P and NX )
Suppose P rises.
 U.S. interest rates rise (the interest-rate effect).
 Foreign investors desire more U.S. bonds.
 Higher demand for $ in foreign exchange
market.
 U.S. exchange rate appreciates.
 U.S. exports more expensive to people abroad,
imports cheaper to U.S. residents.
Result: NX falls.
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
29
The Slope of the AD Curve: Summary
An increase in P
reduces the quantity
of g&s demanded
because:
 the wealth effect
(C falls)
 the interest-rate
effect (I falls)
 the exchange-rate
effect (NX falls)
P
P2
P1
AD
Y2
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Y1
Y
30
↑ PL  ____ Real Output Purchased
Price
Level
 PL  ____ Real Output Purchased
PL2
PL   quantity of real output
purchased
PL1
AD
Y2
Y = output = income
Real GDP = Real Output
Y1
Real GDP
Shifts in Aggregate
Demand (AD)

There are two parts to a shift in AD:

A change in C, IG, G and/or XN

A multiplier effect that produces a greater
change than the original change in the 4
components

Increases in AD = AD right

Decreases in AD = AD left
Consumption
Consumer
More
right)
Less
wealth
wealth = more spending (AD shifts
wealth = less spending (AD shifts left)
Consumer
expectations
Positive
expectations = more spending (AD
shifts right)
Negative
shifts left)
expectations = less spending (AD
Consumption Cont’d
Household
indebtedness
Less
debt = more spending (AD shifts right)
More debt = less spending (AD shifts left)
Taxes
Less
taxes = more spending (AD shifts right)
More taxes = less spending (AD shifts left)
Gross Private Investment
 The
Real Interest Rate
 Lower
Real Interest Rate = More Investment (AD right)
 Higher
 Expected
 Higher
 Lower
Real Interest Rate = Less Investment (AD left)
Returns
Expected Returns = More Investment (AD right)
Expected Returns = Less Investment (AD left)
 Expected
Returns are influenced by
 Expectations
of future profitability
 Technology
 Degree
of Excess Capacity (Existing Stock of Capital)
 Business
Taxes
AD1 AD2
PL
Change in Consumer Spending
Consumer Wealth [increases/decreases]
[stocks/houses] [stable prices]
Consumer Expectations [about future prices (increases/decreases)
Consumer Expectations about future income [positive/negative]
Consumer Indebtedness [low/high]
Personal Taxes [increase/decrease]
Real Interest Rate [stable prices] [increase/decrease]
High Debt
Change in Investment Spending
Real Interest Rates [stable prices] [increase/decrease]
[Positive/Negative] Profit Returns
[Business taxes [increase/decrease]
[Depleted/Excess] inventory stockpiles in the supply chain
↑ PL  ____ Real Output Purchased
 PL  ____ Real Output Purchased
Wealth and income are different. Income is earned from use
of factors of production. Wealth is accumulation of savings,
financial investments, real estate, etc. Wealth is separate from
Income.
↑PL  ____ purchasing power of accumulated wealth 
_____ current consumption  _____ real output purchased.
 PL  ____ purchasing power of accumulated wealth 
_____ current consumption  _____ real output purchased.
↑ PL  ____ Real Output Purchased
 PL  ____ Real Output Purchased
The interest rate (i) is the price of borrowed money.
↑PL  ____ DM  ____ interest rate  ____ C / I
(interest rate sensitive consumption/investment) 
_____ real output purchased.
 PL  ____ DM  ____ interest rate  ____ C / I
(interest rate sensitive consumption/investment) 
_____ real output purchased.
↑ PL  ____ Real Output Purchased
PL  ____ Real Output Purchased
___ relative price of X  ___ X
 PL
____ real
___ Xn  output
___ relative price of M  ___ M
purchased
___ relative price of X  ___ X
 PL
____ real
___ Xn  output
___ relative price of M  ___ M
purchased
X = exports; M = imports; X-M = Net Exports (Xn)
Government Spending

More Government Spending (AD shift right)

Less Government Spending (AD shift left)
Net Exports
 Exchange
Rates (International value of $)
Strong $ = More Imports and Fewer Exports = (AD
shift left)
Weak $ = Fewer Imports and More Exports = (AD
shift right)
 Relative Income
Strong Foreign Economies = More Exports = (AD
shift right)
Weak Foreign Economies = Less Exports = (AD
shift left)
1. The process of combining all individual product prices and
quantities into a single unit is (deduction/conglomeration/aggregation).
2. The AD curve shows the amount of (real/nominal) domestic
output which will be purchased at each possible (price/price level).
3. The AD curve is always (up/down) sloping & shows a(an)
(direct/inverse) relationship between output & (price/price level).
4. The income & substitution effects (do/do not) apply to the AD
curve.
AD
Change in AQD
Price Level Change
Point to Point movements
PL1
PL
AQD
PL2
AQD1
AQD2
5. The interest rate effect suggests that an increase in the PL
will (incr/decr) the demand for money, (incr/decr) interest
rates and (increase/decrease) consumption and investment
which would cause a(an) (increase/decrease) in (AD/AQD).
6. The real-balances effect indicates a higher price level will
(increase/decrease) the real value of money, (increase/decrease)
consumption, and therefore (increase/decrease) (AD/AQD).
7. The foreign purchase effect suggests that an increase in PL
relative to other countries (increase/decrease) our exports and
(incr/decr) our imports which would (incr/decr) (AD/AQD).
AD
PL2
PL1
Lower PL
Higher PL
AQD2
AQD1
19. An increase in the price of imported resources [resource cost] would
cause the (AD/AS) curve to shift (rightward/leftward).
20. A rightward shift of the PPC will shift the (AD/AS) curve to the (right/left).
21. An improvement in productivity [technological improvement] will
shift the (AD/AS) curve to the (right/left).
Suppose that real domestic output is 40 units, the quantity of inputs
is 20 & the price of each input is $8.
22. What is the level of productivity? Productivity(__)
2 = Output(40)
Inputs (20)
23. What is the per unit cost of production? Total input cost $160($8x20)
Per unit production cost ($___)
Units of output (40)
4 =
24. If the price of each input increased from $8 to $12, productivity would
(increase/decrease/ remain unchanged. [affects only per unit cost]
25. Increase in input price [$8 to $12] would shift the (AD/AS) curve (right/left).
26. An increase in the price of imported resources would increase per
unit production cost and shift the (AD/AS) curve to the (right/left).
27. A depreciation of the dollar would cause imported inputs to be more
expensive & shift the AS curve to the (right/left), however, the cost of
our products would decrease so it would shift the AD curve (right/left).
8. There are (3/4) AD Shifters, that have nothing to do with PL.
They are consumption (“C”), investment (“IG”), “G” , & Xn.
9. An increase in consumption will shift the (AD/AS) curve to the (right/left).
10. (A change in PL/A decline in the interest rate no change in PL) will cause a
shift in the AD curve to the (right/left).
11. An increase in the PL will cause a (shift in the AD curve to the left/shift in
the AD curve to the right/decrease in AQD [movement up along a stable AD curve]).
12. An increase in investment caused by a decline in the interest rate [independent
of the PL] will (cause a movement along a stable/shift the) AD curve to the (right/left).
13. If the government decides to spend $60 billion on the infrastructure,
this will shift the (AD/AS) curve to the (right/left).
14. If the national incomes of our major trading partners were to decrease,
[therefore Xn will change] our (AD/AS) curve would shift to the (right/left).
15. (An increase in the PL/A decline in business taxes) would not shift the AS curve.
Horizontal
16. “Range 1” of the AS curve is call_____________,
“range 2”
is called Intermediate
_____________, & “range 3” is called Classical
_________.
3
1
2
17. An increase in the PL will cause a(n) (shift to the right of the AS curve/
shift to the left of the AS curve/increase in the AQS [move up a stable AS curve]).
18. A decrease in the PL will cause a(n) (shift to the left of the AS curve/shift to the
right of the AS curve/decrease in AQS [move down a stable AS curve[)
Aggregate Supply
The
level of Real GDP (GDPR) that firms will produce at each Price
Level (PL)
Is
producing a unit profitable or not?
Short-Run Aggregate
Supply (SRAS)

Increases in the price-level will increase firm’s profits and create
incentives to increase output. As the price-level falls, firm’s profits drop
and this creates an incentive to reduce output.

However, nomial wages and other input prices are fixed and don’t
have time to adjust to price level changes
1. The Sticky-Wage Theory
 Imperfection:
Nominal wages are sticky in the short run,
they adjust sluggishly.
 Due to labor contracts, social norms
 Firms and workers set the nominal wage in
advance based on PE, the price level they
expect to prevail.
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
47
1. The Sticky-Wage Theory
 If P > PE,
revenue is higher, but labor cost is not.
Production is more profitable,
so firms increase output and employment.
 Hence, higher P causes higher Y,
so the SRAS curve slopes upward.
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
48
2. The Sticky-Price Theory
 Imperfection:
Many prices are sticky in the short run.
 Due to menu costs, the costs of adjusting
prices.
 Examples: cost of printing new menus,
the time required to change price tags
 Firms set sticky prices in advance based
on PE.
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
49
2. The Sticky-Price Theory
 Suppose the Fed increases the money supply
unexpectedly. In the long run, P will rise.
 In the short run, firms without menu costs can
raise their prices immediately.
 Firms with menu costs wait to raise prices.
Meanwhile, their prices are relatively low,
which increases demand for their products,
so they increase output and employment.
 Hence, higher P is associated with higher Y,
so the SRAS curve slopes upward.
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
50
3. The Misperceptions Theory
 Imperfection:
Firms may confuse changes in P with changes
in the relative price of the products they sell.
 If P rises above PE, a firm sees its price rise before
realizing all prices are rising.
The firm may believe its relative price is rising,
and may increase output and employment.
 So, an increase in P can cause an increase in Y,
making the SRAS curve upward-sloping.
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
51
What the 3 Theories Have in Common:
In all 3 theories, Y deviates from YN when
P deviates from PE.
Y = YN + a (P – PE)
Output
Natural rate
of output
(long-run)
Expected
price level
a > 0,
measures
how much Y
responds to
unexpected
changes in P
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Actual
price level
52
What the 3 Theories Have in Common:
Y = YN + a(P – PE)
P
SRAS
When P > PE
the expected
price level
PE
When P < PE
Y
YN
Y < YN
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Y > YN
53
Short-Run Aggregate
Supply (SRAS)
PL
SRAS
GDPR

SRAS: the schedule of the amount of real
output that will be produced at each
and every price level in a time period
when wages are fixed.

Higher PL increases / lower PL decreases
incentives to produce in the short run.
↑ PL  ____ Real Output Produced
PL  ____ Real Output Produced
Direct or Inverse?
↑PL  ____ Real Output Produced
SRAS
Price
Level
PL  ____ Real Output Produced
PL2
PL   quantity of real output
produced
PL1
Y1
Y2
Real GDP
Input prices (standardized input bought
and sold in bulk quantities)
Changes in productivity
Legal- institutional environment
Input Prices
Domestic Resource Prices
 Wages (75% of all business costs)
 Cost of capital
 Raw Materials (commodity prices)
 Foreign Resource Prices
 Strong $ = lower foreign resource prices
 Weak $ = higher foreign resource prices
 Market Power
 Monopolies and cartels that control resources
control the price of those resources
 Increases in Resource Prices = SRAS 
 Decreases in Resource Prices = SRAS 

key
to understanding shifts in SRAS is per unit cost of production
Productivity - how many outputs can be obtained
from a certain amount of inputs.
Productivity =
real output (10 units)
Inputs (5 units)
An increase in productivity means more real output can be
obtained from the same inputs.
Do productivity changes alter per unit production cost? (If output is
10 units, input quantity is 5 units, and price of each input is $2)
Total input cost($10)[$2x5]
Units of output (10)
Per unit production cost [$1] =
Suppose output doubles to 20 units, input quantity is 5 units, & price of
each unit is $2.
Per unit production cost [.50] = Total input cost($10)
Units of output (20)
Legal-Institutional
Environment


Taxes and Subsidies
 Taxes ($ to gov’t) on business increase per unit
production cost = SRAS 
 Subsidies ($ from gov’t) to business reduce per unit
production cost = SRAS 
Government Regulation
 Government regulation creates a cost of
compliance = SRAS 
 Deregulation reduces compliance costs = SRAS 
PL
LRASSRAS2
SRAS1
AD
2
AD1
SRAS2
AD2
AS Shifters
[REP]
AD Shifters
103
Resource cost
[C+Ig+G+Xn]
Environment
Consumption
YR Y* YI RGDP [legal-institutiona
Investment (gross)
1. Subsidies,
Government
2. Business tax,
Y indicates 3 things:
Spending
3. Business regs.
1.
Output
[GDP]
[infrastructure,
Productivity
2. Income
military spending,
3. Unemployment
health care]
YR – Recession gap
Net eXports
YI – Inflation gap
Y* – Full Employ.
CIG-X
LRAS
• The Long-Run Aggregate Supply or LRAS marks the level of
full employment in the economy (analogous to being on the PPC)
• Because input prices [wages] are completely flexible in the
long-run, changes in PL do not change firms’ real profits and
therefore do not change firms’ level of output. Input providers
have fully adjusted to market forces. This means that the LRAS
is vertical at the economy’s level of full employment.
LRAS
PL
YF
GDPR
LRAS Shifters
 Changes
in the availability of resources- LLCE
 Changes
in productivity
 Policy
incentives
Price
Level
LRAS
SRAS
PL1
AD
YF
Real GDP
AD/AS at full employment
LRAS
AD
SRAS
The LRAS curve is not
influenced by PL.
103 PL
Output at
Full Employment
The SRAS curve is
influenced by PL and
slopes upward because
of sticky-wages and
sticky-prices.
Y* Quantity of Output
Long-Run v. Short-Run

Long-Run

Short-Run
 Period
of time where
input prices are
completely flexible and
adjust to changes in the
price-level
 In the long-run, the level
of Real GDP supplied is
independent of the
price-level
 Period
 EX.
 EX.
At the end of the
contract, a teacher’s
salary is renegotiated
of time where
input prices are sticky
and do not adjust to
changes in the pricelevel
 In the short-run, the level
of Real GDP supplied is
directly related to the
price level
Teacher signs a 2
year contract
http://whitenova.com/thinkEc
onomics/adas.html
Must be
labeled
PL
instead of
just P.
Price
Level
SRAS
PLe
AD
Ye
Real GDP
Output of Goods and Services
Employment / Income
Unemployment
Must be
labeled
REAL
GDP
Price
Level
PLe2
PLe1
Later you may
drop the “e”
SRAS for equilibrium;
but good to do
when just starting.
AD2
AD1
Ye1 Ye2
Real GDP
____ price level
____ output of G&S
____ employment / incomes
____ unemployment
Price
Level
SRAS
PLe1
PLe2
Ye2 Ye1
AD2 AD
Real GDP
____ price level
____ output of G&S
____ employment / incomes
____ unemployment
Demand-Pull Inflation:
___ in AD pull up the PL
Price
Level
LRAS
SRAS
PLe2
PLe1
AD2
AD
YF
Y2
Real GDP (GDPR)
Price
Level
SRAS
SRAS2
PLe1
PLe2
AD
Ye1
Ye2
Real GDP
____ price level
____ output of G&S
____ employment / incomes
____ unemployment
Price
Level
SRAS2
SRAS
PLe2
PLe1
AD
Real GDP
Ye2 Ye1
____ price level
____ output of G&S
____ employment / incomes
____ unemployment
The 3 Situations: No Gap, Recessionary Gap, & Inflationary Gap
AD1
110
SRAS
LRAS
AD3
AD2
103
100
Recess
Gap
[5%(“real”) cyclical unemployment]
10% (5x2%=10%) Recess. GDP Gap
11%
YR
YA
$9
Inflat
Gap
6%
Y*
YP
$10
1% [10%(5x2%) Inflationary GDP Gap
YI
YA
$11
No Gap (Y*) - Potential Output($10 tr.) equals Actual Output($10 tr.)
Actual Unemployment rate(6%) equals Potential Unemployment Rate(6%)
Recessionary Gap - Potential Output($10 Tr.) exceeds Actual Output($9 tr.)
Actual Unemployment Rate(11%) exceeds Potential Unemployment Rate(6%)
Inflationary Gap Potential Output($10 tr.) is less than Actual Output($11 tr.)
Actual Unemployment. Rate (1%) is less than Potential Unemployment Rate (6%)
Cost-Push Inflation:
___ in SRAS push up the PL
Price
Level
SRAS2
LRAS
PLe2
PLe1
SRAS
This condition is also called:
_____Stagflation (inflation and
falling aggregate output)__
AD
Ye2
YF
_____ SRAS _____ PL
Real GDP (GDPR)
_____ GDPR _____ Unemployment
Negative and Positive Supply Shocks
As for SHOCKS. We expect the AS curve to
slowly shift to the right at a predictable rate
one year to the next. Same for AD.
But a SHOCK to the economic system
(much akin to a heart attack or car accident)
cannot be accurately predicted.
We all knew a hurricane would one day hit New
Orleans, or that buying ocean front property in
Nevada will pay-off when California slides away,
but we don't know the year or the magnitude of the
event.
Shocks are not predicted.
[“bad news” – job losses; “bad news” – inflation]
LRAS AS2
AD
$2.
$4.
110
Inflating
PL1
AS1
The economy
is
stagnating
but
inflating
Stagnating
10% Y*
“Stagflation”
[“good news”–job gains; “good news”–disinflation]
AS1
AD
AS2
$4.00
$1.75
PL1
“Good news,
lower prices”
“Good news,
more jobs”
PL2
Y1 Y2

That is, even in an economy producing its potential output,
there is some unemployed labor & unused production capacity.

Potential GDP can be thought of
as the economy’s normal capacity.
LRAS SRAS

PL2(106) AD1
AD2
AD3
PL1(103)
PL3(100)
YR Y*F Yi
YA YP YA
9% 6% 3%
Firms and workers are able, in the short run, to push
output beyond the economy’s potential.
*In the LR, the level of RGDP supplied is independent of PL.
*In the SR, the level of RGDP supplied is dependent of PL.
LRAS
Price
Level
SRAS
AD2
AD
PL2[106]
[Production cost]
E2
What if we have
unanticipated inflation?
What happens in SR to
output, employment,
and price level?
PL1[103]
Y
YI
RGDP
LRAS
Price
Level
PL2[106]
SRAS2
SRAS1
AD
E3
[Production cost]
With unanticipated inflation
what happens to output,
employment and price level
in the LR?
PL1[103]
Y
RGDP
LRAS
Price
Level
AD
SRAS
[Production cost]
With unanticipated
disinflation, what happens
to output, employment,
and price level in the SR?
AD2
PL1[103]
PL3[101]
E2
YR Y
RGDP
How much spending is
needed to close the GDP
gap?



In a recession, spending
is insufficient to reach full Price Level
employment
The shortfall in spending
is called a recessionary
gap.
Because there is a
recessionary gap, a GDP
gap exists (short fall
between actual (Y1) and
potential GDP (YF).
LRAS
SRAS
PL1
AD
Y1
YF Real GDP
Output gap=
GDP Gap
(actual aggregate output – potential output)
X 100
potential output}
The Multiplier Effect
A little change in spending gives rise to a larger change in
income/output (Y) --- initial spending creates additional income that
results in additional spending.
Price Level
LRAS
SRAS
PL1
AD
YF Real GDP
How much spending is
needed to close the gap?

If the GDP gap is $100
billion due to a
recessionary gap in
spending, should
spending be increased
$100 billion to close the
gap?
Price Level
LRAS
SRAS
PL1

Does a certain amount
of spending result in an
equal amount of GDP
(income and output)?
AD
Y1
YF Real GDP
Due to the multiplier effect, a $100 billion increase in spending
would be far too much spending to close the GDP gap. A smaller,
not equal change in AE leads to a desired larger change in GDP.)
How much should
spending be reduced?


An inflationary gap
Price Level
occurs if spending
exceeds the amount
necessary to purchase
the full employment
level of output (YF).
Does a reduction in
spending (AE) result in
an equal decrease in
GDP (income and
output)? WHY?
No – due to the multiplier effect.
LRAS
SRAS
PL1
AD
YF Y1 Real GDP
Actual output > potential output
Output deviates in the short run from the
natural rate when the actual price level
deviates from the price level that people
had expected to prevail.
Quantity
of output
supplied
=
Natural
rate of
output
+
a
Actual
price level
Expected
price level
Contraction in AD
2. . . . causes output to fall in the short run . . .
Price
Level
Long-run
aggregate
supply
Short-run aggregate
supply, AS
AS2
3. . . . but over
time, the short-run
aggregate-supply
curve shifts . . .
A
P
B
P2
P3
1. A decrease in
aggregate demand . . .
C
Aggregate
demand, AD
AD2
0
Y2
Y
4. . . . and output returns
to its natural rate.
Quantity of
Output
The Effects of a Shift in AD
Event: Stock market
crash
P
LRAS
1. Affects C, AD curve
2. C falls, so AD shifts
left
3. SR eq’m at B.
P and Y lower,
unemp higher
4. Over time, PE falls,
SRAS shifts right,
until LR eq’m at C.
Y and unemp back
at initial levels.
SRAS1
A
P1
P2
SRAS2
B
P3
AD1
C
AD2
Y2
YN
Y
A Drop in Consumer Confidence
LRAS
P
SRAS1
SRAS2
P1
P2
P3
AD2
Y
YP
Unemployment  Wages must fall!
AD1
Y
Policy Responses to Recession
 Policymakers
may respond to a recession in one of
the following ways:
Do
nothing and wait for prices and wages to
adjust.
Take
action to increase aggregate demand by
using monetary and fiscal policy.
It’s
harder for the government to shift AS
Accommodating Adverse Shift in AS
1. When short-run aggregate
supply falls . . .
Price
Level
Long-run
aggregate
supply
P3
C
P2
A
3. . . . which P
causes the
price level
to rise
further . . .
0
4. . . . but keeps output
at its natural rate.
Natural rate
of output
Short-run
aggregate
supply, AS
AS2
2. . . . policymakers can
accommodate the shift
by expanding aggregate
demand . . .
AD2
Aggregate demand, AD
Quantity of
Output
Points of Emphasis for AD/AS Questions
1. Wages
(labor), this is resource cost, so AS shifter.
2. Increase/decrease in union workers hired – they get paid
more – so labor, so AS shifter.
3. Appreciation/depreciation of a currency [either AD or AS]
a. Resource cost is part of REP, so it is AS shifter.
b. Exports are part of C+Ig+G+Xn, so it is AD shifter.
4. Regulations and subsidies [legal-institutional
Environment], part of REP, so they are AS shifters.
5. For all C+Ig+G+Xn, does the situation result in an increase
or decrease in AD & therefore GDP?
6. For REP, think of production costs –
if producers make more money, there is an increase in AS,
if producers make less money – there is a decrease in AS.
http://whitenova.com/thinkEc
onomics/simul.html
2008 FR B
11 points: (2 + 2 + 2 + 3 + 2)
Assume that the economy of Country Z is operating on
the upward-sloping portion of its short-run aggregate
supply curve. Assume that the government increases
spending.
 (a) How will the increase in government expenditures
affect each of the following in the short run?
 (i) Aggregate demand
 (ii) Short-run aggregate supply

(b) Using a correctly labeled graph of aggregate
demand and aggregate supply, show the effect of
the increase in government expenditures on real
output and the price level.
 (c)
Assume that the government funded
this increase in expenditure by borrowing
from the public. Using a correctly labeled
graph of the loanable-funds market, show
the effect of the increase in government
borrowing on the real interest rate.
 (d)
Given the change in the real interest
rate in part (c), what will be the effect on
each of the following on the foreign
exchange market?
(i) Supply of Country Z’s currency. Explain.
(ii) The value of Country Z’s currency
 (e)
Given your answer in part (d) (ii), what
will be the effect of the change in the
value of Country Z’s currency on Country
Z’s exports? Explain.
Answer:





(a) 2 points:

One point is earned for stating that the aggregate demand will
increase.

One point is earned for recognizing that the short-run aggregate
supply is not affected.
(b) 2 points:

One point is earned for a correctly labeled graph of aggregate
demand and aggregate supply.

One point is earned for showing a rightward shift of the
aggregate demand curve and showing an increase in both real
output and the price level.
(c) 2 points:

One point is earned for a correctly labeled graph of the
loanable-funds market.

One point is earned for showing a rightward shift of the demand
curve for funds and concluding that the real interest rate will rise.
(A leftward shift of the supply curve is accepted.)
(d) 3 points:

One point is earned for stating that the supply of Country Z’s
currency will decrease.

One point is earned for the explanation that the higher interest
rate reduces the outflow of funds to countries that now have a
relatively lower interest rate.

One point is earned for concluding that the value of Country Z’s
currency will rise or Country Z’s currency will appreciate.
(e) 2 points:

One point is earned for stating that Country Z’s exports will
decrease.

One point is earned for the explanation that the appreciating
currency makes Country Z’s goods relatively more expensive.
2006 FR 11 pts (3+2+2+3+1)
Assume that the US economy is currently operating at an equilibrium
below full employment.
A. Draw a correctly labeled graph of ADAS, and show each of the
following


Long Run Aggregate Supply
Current equilibrium output and price level
B. Now assume a significant increase in the world price of oil, a major
production input in for the US. Show on your graph in part (a) how
the increase in the oil price affects each fo the following in the short
run


Short Run Aggregate Supply
Real output and price level
C. Given your answer in part (b), explain what will happen to
unemployment in the US in the short run.
D. Assume the US trade with Japan, Draw a correctly labeled graph of
the foreign exchange market for the US dollar. Based on your
indicated change in real output in part (b) show and explain how the
supply of the US dollar will be affected in the foreign exchange
market.
E. Given your answer in part (d), indicated what will happen to the US
dollar relative to the Japanese yen
a.
Answer:
b.
c.
d.
e.
One point is earned for AS/AD
graph.
one point is earned for showing a
vertical LRAS
one point is earned for showing
current output and PL below full
employment
One point is earned for showing
a leftward shift of the SRAS curve
one point is earned for showing
that real output falls and price
level rises.
One point is earned for stating that
unemployment increases
one point is earned for
explaining that the cause is the
decrease in real output
One point is earned for a
correctly labeled graph
One point is earned for
explaining that the fall in real
income will cause the demand
for imports to decrease
One point is earned for showing
that the supply curve for dollars
will shift to the left
One point is earned for stating the
US dollar will appreciate.
and
Should the government intervene to correct problems
in the economy?
PL
LRAS
PL
SRAS
LRAS
SRAS
PL2
PL1
PL1
PL2
AD2
AD2
Y2 YF
AD1
AD1
YF
GDPR
 AD ____ PL ____ Unemployment
Y2
GDPR
 AD ____ PL ____ Unemployment
Between PL and Unemployment:
(in the short run)
Click the mouse once to fill in the blanks.


In the short run there is a TRADE-OFF between INFLATION and
UNEMPLOYMENT.

To reduce unemployment – inflation occurs

To reduce inflation --- unemployment increases
Research by an English economist named Phillips documented this relationship. As a
result a new model was developed to illustrate the trade-off:
Inflation
Rate
Inflation
Rate
%1
%2
%2
SRPC
U1
%1
U2 Unemployment
Rate
 Inflation rate   unemployment rate
SRPC
U2
U1 Unemployment
Rate
 Inflation rate  ↓ unemployment rate
Due to the trade-off (inverse relationship), what is the shape of the SRPC?

The trade-off presents a problem for government fiscal (Congress &
President) and monetary (The FED) policymakers:

Insufficient AD  recession  policymakers to take steps to __ AD
 ________________

Too much AD  inflation  policymakers to ___AD  
____________________.
Address the problem without creating a
worse problem – limit the negative effects.

When stagflation first occurred in the 1970s due to a supplyside shock (  price of oil/energy), it created a new dilemma
for policymakers and called into question the credibility of the
short run Phillips Curve (SRPC) relationship.
Short Run Supply Shocks



Tightness in the labor market.

Suppose that because of a big economic expansion, the economy is producing at
an output level Y that is greater than YP.

This suggests that the economy is using more labor than it normally does.

To get people to work longer hours, you have to pay them more.

This increase in labor costs will shift the SRAS curve left, as profit per output falls
when labor costs rise.
Expectations about inflation

If workers expect inflation to be higher in the future, they will demand higher wages
in anticipation of this increase in the cost of living.

Higher wages reduce firm profit and shift SRAS left
Supply shocks to critical raw materials

Suppose a war broke out between the US and Iran. Oil prices would rise
dramatically

Since oil is such a pervasive part of nearly everything we produce, production costs
would rise significantly.

The SRAS curve would shift left as the return on production fell.
LRAS
PL
SRAS2
SRAS1
PL2
Does stagflation negate
the SRPC trade-off
between inflation and
unemployment?
It appears to negate the inverse
relationship. Both PL and
unemployment increase!
PL1
Some economists rejected
the SRPC relationship;
others found an
alternative explanation.
AD
Y2
YF
GDPR
 SRAS  ____ PL ____ Unemployment
Inflation
Rate
Inflation
Rate
%
%2
SRPC2
%1
SRPC2
SRPC1
U
Unemployment
Rate
SRPC1
U1
U2
Unemployment
Rate
Stagflation simply caused the SRPC to shift to the right --- indicating that for
each level of unemployment, there is a higher rate of inflation; for each
inflation rate, there is a higher level of unemployment.
LRAS
PL
Inflation
Rate
SRAS1
SRAS2
For each level of inflation,
a lower level of unemployment exists.
%1
PL1
SRPC1
%2
PL2
SRPC2
AD
YF Y2
U
Unemployment
Rate
GDPR
 SRAS  ____ PL ____ Unemployment
For each level of unemployment,
a lower level of inflation exists.

Short Run: a period of time in which wages do NOT
adjust to price level changes (insufficient time for
adjustment)

Long Run: a period of time in which wages adjust to
price level changes; sufficient time for labor contracts
to end and be renegotiated; sufficient time for labor to
realize the impact of price level changes on real
income.
If the government chooses to let the
economy fix itself (classical
economics)…





What is currently happening to the PL when there is
inflation?
Because of the higher price level businesses are making
more money.
Wages have remained the same in the short run! But our
real wages have decreased!
So we are making the less money and businesses are
making more.
We will go to our work place and tell our bosses:



Give me a raise or
I quit (they will not be able to replace you because U% is low (lower
than natural rate- there are very few people looking for jobs)
Because wages have increased, it is more expensive to
produce, causing SRAS to shift to the left.
The Self-Correcting Economy

Suppose that a decrease in consumer confidence causes the
aggregate demand curve to shift left.

At current prices, there will be a surplus of production as consumers
demand fewer goods and services

Firms will cut both their prices and their production until the surplus
inventory is sold.

Output and prices fall in the short run, resulting in a recession.

Eventually, lower output prices and less demand for labor will induce
a fall in production costs.

The SRAS curve will shift right until full employment output is restored at
a lower price (assuming consumer confidence never recovered).

The economy will always return to full-employment output, but how
long does this adjustment process take?
SR vs. LR Effects of AD
PL
PL3
In the short run, an  AD moves
equilibrium from a to b, thus  PL and
output and  unemployment.

In the long run, an  AD eventually
moves the economy from a to c 
(after a wage   SRAS) resulting in
an PL but no change in output and
unemployment.
SRAS2
SRAS1
LRAS
c
PL2
PL1

b
a
AD2
AD1
YF Y2
GDPR
Conclusion: In the LR, an  AD does not have an effect on output and unemployment.
No trade-off exists between inflation and unemployment in the LR.
If the government chooses to let
the economy fix itself (classical
economics)…
What is currently happening to the PL in a recession?


Because of the lower price level businesses are making less money.

Wages have remained the same in the short run! But our real wages have
increased.

So we are making the more money and businesses are making less.

They will tell their employees they have 2 choices:


Take a wage cut or

You’re fired (they will replace you because U% is high- someone will want your job at
a lower wage)
Because wages have decreased, it is cheaper to produce, causing SRAS to
shift to the right.
SR vs. LR Effects of AD

PL
LRAS
SRAS1
In the short run, a  AD moves
equilibrium from a to b, thus PL and
output and  unemployment.
SRAS2 In the long run, a  AD eventually
PL1
PL2
moves the economy from a to c (after
a  wages SRAS)  PL but having no
change in output and unemployment
(back to YF).
a
b
PL3
c
AD2
Y2 YF
AD1
GDPR
Conclusion: In the LR, an  AD does not have an effect on output and unemployment.
Implications for the LRPC of
changes in AD?
Inflation
rate
LRPC
In the LR, no
trade-off exists
between inflation
and unemployment –
only the PL (inflation)
changes while unemployment remains
constant at the NRU.
What is the shape
of the LRPC if the
LR only changes
PL and has no impact on output and
unemployment?
(vertical)
At what level of
Unemployment is the
LRPC located? (NRU)
UNRU
Unemployment Rate
Use two separate graphs to illustrate appropriately
labeled short run and long run Phillips curves.
Inflation
rate
Inflation
rate
LRPC
SRPC
Unemployment
Rate
UNRU
Unemployment
Rate
2
2
2
2
[“REP”]
D
___33.
Decrease in the availability of key natural resources (R)?
C
___34.
Increase in resource productivity (P)?
A
___35.
Increase in foreign spending on our products (Xn)?
B
___36.
Substantial reduction in government spending (G)?
C
___37.
Declines in the prices of imported resources (R)?
B
___38.
Declines in the incomes of our trading partners (Xn)?
A
___39.
Improvement in business profit expectations (Ig)?
B
___40.
Stock market plunge affects consumer wealth (C)?
B
___41.
There is an increase in interest rates [stable prices] (C & Ig)?
A
___42.
Consumer indebtedness is very low (C)?
Extra:
D
___43.
Increased government regulations are forced on businesses (E)?
C
___44.
The government increases subsidies to all farmers (E)?
Points of Emphasis for AD/AS
Questions
2. Increase/decrease in union workers hired –
1. Wages (labor), this is resource cost, so AS shifter.
they get paid more – so labor, so AS shifter.
3. Appreciation/depreciation of a currency [either AD or AS]
a. Resource cost is part of REP, so it is AS shifter.
b. Exports are part of C+Ig+G+Xn, so it is AD shifter.
4. Regulations and subsidies [legal-institutional
Environment], part of REP, so they are AS shifters.
5. For all C+Ig+G+Xn, does the situation result in
an increase or decrease in AD & therefore GDP?
6. For REP, think of production costs –
if producers make more money, there is an increase in AS,
if producers make less money – there is a decrease in AS.
[“REP”]
B
__1.
Consumers fear a widespread depression.
__2.
Britain and Japan increase their purchases of U.S.
A
agricultural products.
__3.
Our exports are affected by a depreciation of the dollar.
A
A
__4.
There is a huge increase in government spending
for health care.
__5.
Interest rates increase although prices are stable.
B
B
__6.
20% increase in the personal income tax.
C
__7.
An increase in labor productivity.
C
__8.
A 15% decrease in nominal wages.
__9.
Appreciation of the dollar affects imported resources.
C
A
__10.
Canada, Mexico, & Japan come out of recession
and buy more American cars.
[“REP”]
A widespread fear of depression on the part of consumers.
___2.
A large purchase of wheat by Russia, one of our trade partners.
A
B
___3.
Our exports are affected by an appreciation of the dollar.
___4.
A reduction in interest rates although price level remains constant.
A
B
___5.
A huge cut in government expenditures for health care.
A
___6.
Consumer expectations of a rapid rise in the price level.
C
___7.
The complete disintegration of OPEC, causing oil prices to fall by ½.
___8.
A 10% reduction in personal income tax rates.
A
C
___9.
An increase in labor productivity.
D
___10.
A 12% increase in nominal wages.
D
___11.
Imported resources are affected by a depreciation of the dollar.
B
___12.
A sharp decline in the national incomes of our trading partners.
C
___13.
A decline in the % of the U.S. labor force which is unionized.
B
___1.
Part 1: Why is the AD Curve Downsloping?
1. The relationship between the PL and real
domestic output is (direct/inverse).
2. Explain how each of the following effects
explain why the AD curve, at lower price
levels is downward sloping.
A. Interest rate effect - a lower PL means a
[lower/higher) interest rate resulting in
(decreased/increased) output.
B. Real-balances effect – a lower PL will
(decrease/increase) the value of our
wealth & result in (decreased/increased)
output.
C. Foreign purchases effect – a lower PL will
make our goods (cheaper/more expensive)
relative to other countries and will result
in (increased/decreased) output.
“Change in AQD”
[Change in PL]
[Movement]
[Point to point]
AD
PL1
PL2
AQD1
AQD2
Real GDP
AD Shifters (C+Ig+G+Xn)
“Change in AD” [non PL/shift/whole curve]
A
E
B “C” D
CIG-X
PL
Part 2: Shifts in AD
A. Increase AD?
B. Decrease AD?
C. No Change in AD (movement)
D. Do not shift beyond A or E
Real GDP
*We will start at AD curve “C”.
D
1. Congress funds ten new military bases with $20 billion.
AD__Curve__
+
2. Due to consumer pessimism, businesses cut back on Ig. AD__Curve__
C
3. Ten billion G revenues are sent to Texas to help on “High 10”. AD__Curve__
D
+
4. Foreigners increase their demand by 50% for our computers. AD__Curve__
+
E
5. Business leaders feel economy is headed for a recession. AD__Curve__
D
6. Stock market collapses and investors lose billions.
AD__Curve__
C
NC
7. Productivity is up for 3rd straight year due to increases in technology. AD__Curve__
C
8. President and Congress cut defense spending by 20%
AD__Curve__
B
and there is no increase in domestic spending.
Classical
Part 3:
PL
Intermediate
Keynesian
Real GDP
1. Under what conditions would AS be in the Keynesian range?
Very bad recession or a depression
(horizontal) _______________________________________________
2. Under what conditions would AS be in the classical range?
Very “hot” economy, such as WWII
(vertical) _________________________________________________
3. Under what conditions would AS be in the intermediate range?
At, near, or just beyond full employment
_________________________________________________________
4. What range do you think AS is in today?
Toward the end of the Keynesian range
_______________________________________________________
We are in the most serious recession since the Great Depression.
Why?_____________________________________________________
AS Shifters [“REP”]
“Change in AS” [non PL/shift/whole curve]
A
E
B “C” D
PL
AD
“REP”
Part 4: Shifts in AS
A. Increase AS?
B. Decrease AS?
C. No Change in AS (movement)
D. Do not shift beyond A or E
Real GDP
*We will start at AS curve “C”.
1. Unions grow more aggressive and wages increase.
2. OPEC successful increases oil prices [resource cost].
3. Labor productivity increases dramatically.
4. Giant natural gas discovery decreases energy prices.
5. Computer technology brings new efficiency to industry.
6. Government spends $20 billion on highways.
7. Government announces all auto owners must install $5,000
car engines so that all autos can be fueled by carrot juice.
8. The international value of the dollar decreases by 20%
and affects prices of resources bought overseas.
B
AS__Curve__
A
AS__Curve__
AS__Curve__
B
+
+
AS__Curve__
C
+
AS__Curve__
D
NC
AS__Curve__
D
C
AS__Curve__
-
AS__Curve__
B
AD
Part 5: Equilibrium
AS
PL2
PLe
PL1
Real GDP
Qe
1. The equilibrium PL is ____
Qe
PLe & the equilibrium output level [output] is ____.
2. If the initial PL and output were PL2 rather than Pe, equilibrium PL would
(increase/decrease) and equilibrium output level would (increase/decrease).
3. If the initial PL were PL1 rather than Pe, equilibrium PL would
(increase/decrease) and equilibrium output would (increase/decrease).
Part 6: Changes in Equilibrium
Illustrate the change on the AD/AS graph and indicate the
effect on PL
AS
PL
and output
by underlining
either:
increase/decrease/stays
1. Congress
passes
a middle-class
tax cut
and the
AD2
AD1
the same.
President
signs it.
PL:
(increase/decrease/stays the same)
Real GDP: (increase/decrease/stays the same)
PL2
PL1
2. During a Great Depression the government increases spending PL
on schools, highways, and other public works by $2 billion.
PL:
(increase/decrease/stays the same)
Real GDP: (increase/decrease/stays the same)
3. New oil discoveries cause large decreases in energy
prices.
PL:
(increase/decrease/stays the same)
Real GDP: (increase/decrease/stays the same)
4. Illustrate the effects of demand-pull inflation.
PL:
(increase/decrease/stays the same)
Real GDP: (increase/decrease/stays the same)
E2
E1
Y1 Y2
AS
AD1 AD2
PL1
E1
Y1
PL
E2
Y2
AD AS1AS2
PL1
PL2
PL
E1
E2
Y1 Y2
AS
AD2
AD1
PL2
PL1
E2
E1
Y1Y2
Changes in Equilibrium [Continued]
5. Illustrate the effects of cost-push inflation [Stagflation]
PL
AD
PL:
(increase/decrease/stays the same)
Real GDP: (increase/decrease/stays the same)
6. New technology and better education increase productivity.
PL:
(increase/decrease/stays the same)
Real GDP: (increase/decrease/stays the same)
PL2
PL1
PL
8. With an unemployment rate at 7%, the government
reduces taxes and increases government spending.
PL:
(increase/decrease/stays the same)
Real GDP: (increase/decrease/stays the same)
AD
AS1AS2
E1
E2
PL2
PL
E2
E1
Y2Y1
PL1
7. New President says all AP Econ students who make “A’s” PL
in econ can go to college free. [G will pick up the tab]
PL2
PL:
(increase/decrease/stays the same)
PL1
Real GDP: (increase/decrease/stays the same)
AS2
AS1
AD1
Y1Y2
AD2 AS
E2
E1
Y1 Y2
AS
AD2
AD1
PL2
PL1
E2
E1
Y1Y2
1. D
2. A
3. A
4. A
A. Increase in AD
C. Increase in AS
5. B
6. B
7. C
8. A
9. A
10. C
[C+Ig+G+Xn] B. Decrease in AD
[“REP”]
D. Decrease in AS
1. Car producers have new regulations imposed on them
that require pollution devices on the tailpipes to cut pollution.
2. Positive business profit expectations affect investment.
3. A 50% increase in the value of stocks affect consumer spending.
4. The government will start paying health care for the nations
35 million poor.
5. Although the price level is constant, the Fed raises interest rates.
6. Government spending is affected by the closing of 50 military
bases and decreasing Armed Forces personnel by 250,000 men.
7. The dollar appreciates by 20% which affect the price of
imported resources.
8. Congress cuts personal income taxes by 10% which affect
consumer spending.
9. Investment is affected after factory inventories are being
depleted. [“hot economy”]
10. Productivity (over a 6 month period) triples in the economy.
1.
2. B 3.in
D AD
4. A[C+Ig+G+Xn]
5. A 6. A 7. DB. 8.
B 9. B in
10.
A
A. CIncrease
Decrease
AD
C. Increase in AS
[“REP”]
D. Decrease in AS
1. Regulations on car producers are suspended that required
pollution devices on all auto tailpipes.
2. Negative business profit expectations affect investment.
3. A 12% increase in wages impact business profits.
4. The government will spend $1 billion on the “High 10” at
Hwy 190 and Central Expressway.
5. Although the price level is constant, the Fed drops interest rates.
6. Government spending is affected by the construction of a
10-lane highway between Washington D. C. and Crawford, Texas.
7. The dollar depreciates by 10% which affect U.S. resource cost.
8. Congress raises personal income taxes by 10% which
affect consumer spending.
9. Investment is affected after the economy goes into a very
bad recession.
10. Canada, Mexico, and Japan buy 50 million more tons of
corn.
A. Incr in AD
B. Decr in AD
C. Incr in AS
D. Decr in AS
[C+Ig+G+Xn]
[REP]
1. B 2. A 3. D 4. A 5. D 6. B 7. A 8. A 9. C 10. A
Which diagram above portrays:
___1. A decrease in consumer spending?
___2. The impact on net exports caused by increases in the
national incomes of our major trading partners?
___3. A large increase in the price of imported oil which
impact the resource cost of businesses?
___4. A large increase in government spending on our highways.
___5. A substantial increase in wages that businesses pay
their workers?
___6. The effect on investment if there are negative business
profit expectations? [“We are heading into a recession.”]
___7. A decrease in interest rates even though there is no
change in price level?
___8. The government picking up the tuition tab for all of the
nation’s private school students who have made a “90”
or above in high school economics?
___9. A major increase in productivity?
___10. 25% stock market increase over a two month period?
AD2
LRAS
AD1
SRAS1
SRAS2
YR
Y*
1. If AD remains constant, the equilibrium price levels in the
OA
OB
short run and in the long run will be _____
& _____?
2. If the government uses fiscal policy to get out of the
OC
recession, price level will end up at _____?
“Chg in AQD”
“Chg in AD”
1. Price level changes cause
(shifts of the AD or AS curve/movements
from one point to another on a stable AD or AS curve[changes in AQD or AQS].
2. What 3 effects cause an increase or decrease in AQD?
Foreign purchase
Interest Rate
Real-balance ___________________,
_____________,
& ________________
effects.
change in price level
3. What will not shift the AD or AS curves? ________________
4. How does a decrease in price level affect the: real value of
wealth? (increase/decrease); consumption? (incr/decr); &
increases/decreases) (AD/AQD).
5. What does an increase in price level do to the demand for
money? (increase/decrease); affect interest rates? (incr/decr);
affect consumption? (incr/decr); & incr/decr) (AD/AQD).
6. A decreasing U.S. price level (incr/decr) U.S. exports and
(increases/decreases) (AD/AQD).
7. An increase in the national incomes of our trading partners
(incr/decr) our net exports which will lead to an (incr/decr)in (AD/AQD).
8. An appreciation of the dollar will (incr/decr) AS but (incr/decr) AD.
A depreciation of the dollar will (incr/decr) AS but (incr/decr) AD.
9. If the interest rate decreases because price
level decreases
we will have an (increase/decrease) in
(AD/AQD).
10. If the interest rate decreases but price level
remains constant
11. If the
PPC shifts out (more resources or technology), then
we will have an (increase/decrease) in
the (AD/AS) curve shifts (right/left).
(AD/AQD).
12. Productivity (is/is not) affected when resource cost decreases.
13. What economic event brought the curtain down on the classical
The Great Depression
show?_______________________________________
What economic event brought the curtain down on the Keynesian
Stagflation
show? _______________________________________
Joseph Say
14. Who said “Suply creates demand?” ________________
15. During a depression, the policy of the (Classicals/Keynesians)
is “Do nothing.”
16. The (Classicals/Keynesians) believe government should
take an active role.
17. The (Classicals/Keynesians) said, “Savers save more at
higher interest rates.”
REP
C+Ig+G+Xn
PL2
E2
E2
Y2
A. Increase in AD
C. Increase in AS
[C+Ig+G+Xn]
[“REP”]
B. Decrease in AD
D. Decrease in AS
1. Regulations on car producers are increased that require
pollution devices on all auto tailpipes.
2. Positive business profit expectations affect investment.
3. A 10% decrease in wages impact business profits.
4. The government will spend $75 billion less as it closes 75
domestic military bases.
5. Although the price level is constant, the Fed drops interest rates.
6. Government spending is affected by the U.S. instituting
nationalized healthcare.
7. The dollar appreciates by 10% which affect U.S. resource cost.
8. Congress decreases personal income taxes by 20% which
affect consumer spending.
9. Investment is affected after the economy goes into a very
severe recession.
10. The U.S. buys 50 million more tons of sugar cane imports
from Brazil & they buy less of our beef and other exports.
1. D
2. A
3. C
4. B
5. A
6. A
7. C
8. A
9. B
10. B
A. Increase in AD
C. Increase in AS
[C+Ig+G+Xn] B. Decrease in AD
[“REP”]
D. Decrease in AS
1. U.S. factories have new regulations imposed on them
that require them to cut pollution by 25%.
2. Negative business profit expectations affect investment.
3. A 20% decrease in the value of stocks affect consumer spending.
4. The government will give $60 billion to the states so they can
repair their aging bridges and highways.
5. Although the price level is constant, the Fed raises interest rates.
6. Government spending is affected by the closing of 30 military
bases and decreasing the Armed Forces by 150,000 men.
7. The dollar depreciates by 20% which affect the price of
imported resources.
8. Congress increases personal income taxes by 13% which
affect consumer spending.
9. Investment is affected after factory inventories are being
depleted. [“hot economy”]
10. U.S. productivity declines because of several earthquakes
in California, Texas and New York.
1. D 2. B 3. B 4. A 5. B 6. B 7. D 8. B 9. A 10. D
“Chg in AQD”
“Chg in AD”
1. Price level changes cause
(shifts of the AD or AS curve/movements
from one point to another on a stable AD or AS curve[changes in AQD or AQS].
2. What 3 effects cause an increase or decrease in AQD?
Foreign purchase
Interest Rate
Real-balance ___________________,
_____________,
& ________________
effects.
change in price level
3. What will not shift the AD or AS curves? ________________
4. How does a decrease in price level affect the: real value of
wealth? (increase/decrease); consumption? (incr/decr); &
increases/decreases) (AD/AQD).
5. What does an increase in price level do to the demand for
money? (increase/decrease); affect interest rates? (incr/decr);
affect consumption? (incr/decr); & incr/decr) (AD/AQD).
6. A decreasing U.S. price level (incr/decr) U.S. exports and
(increases/decreases) (AD/AQD).
7. An increase in the national incomes of our trading partners
(incr/decr) our net exports which will lead to an (incr/decr)in (AD/AQD).
8. An appreciation of the dollar will (incr/decr) AS but (incr/decr) AD.
A depreciation of the dollar will (incr/decr) AS but (incr/decr) AD.
9. If the interest rate decreases because price
level decreases
we will have an (increase/decrease) in
(AD/AQD).
10. If the interest rate decreases but price level
remains constant
11. If the
PPC shifts out (more resources or technology), then
we will have an (increase/decrease) in
the (AD/AS) curve shifts (right/left).
(AD/AQD).
12. Productivity (is/is not) affected when resource cost decreases.
13. What economic event brought the curtain down on the classical
The Great Depression
show?_______________________________________
What economic event brought the curtain down on the Keynesian
Stagflation
show? _______________________________________
Joseph Say
14. Who said “Suply creates demand?” ________________
15. During a depression, the policy of the (Classicals/Keynesians)
is “Do nothing.”
16. The (Classicals/Keynesians) believe government should
take an active role.
17. The (Classicals/Keynesians) said, “Savers save more at
higher interest rates.”
(96%) 1. Under which of the following conditions would consumer spending increase?
AD/AS Questions From 2005 AP Exam
a. consumers have large unpaid balances on credit cards.
b. consumers wealth is increased by changes in the stock market.
c. Social Security taxes are increased.
(79%) 2. An increase in which of the following will increase AD?
a. Taxes b. Government spending c. Federal funds rate d. RR e. Discount rate
(71%) 3. A favorable supply shock, such as a decrease in energy prices is most
likely to have which of the following short-run effects on the PL and output.
Price Level Output
a. Decrease
No effect
b. Decrease
Increase
SRAS2
LRAS
c. Increase
Increase
SRAS
d. Increase
Decrease
AD
e. No effect
No effect
(51%) 4. Assume that the economy is at fullPL2
employment equilibrium in the diagram to the
right. Which answer would lead to stagflation? PL
a. Leftward shift of the SRAS curve only
b. Rightward shift of the SRAS curve only
c. Leftward shift of the AD curve only
d. Rightward shift of the AD curve only
e. Rightward shift in both the SRAS curve
YR Y* Real GDP
and the AD curve
(61%) 5. A change in which of the following will cause the short-run AS curve to shift?
2005 AP
I. The price level
II. Government spending
III. The
cost of all inputs
Exam
a. I only
b. II only
c. III only
d. I & II only
e. I, II, & III
(65%) 6. In an economy with a horizontal AS curve, an increase in
government spending will cause output and PL to change in which ways?
Output
Price Level
a. Decrease
Increase
b. Increase
Increase
c. Increase
No Change
d. No change Increase
e. No change No change
(65%) 7. The AD curve is downward sloping because as the PL increases the
a. purchasing power of wealth decreases
b. demand for imports decreases
c. demand for interest-sensitive expenditures increases
d. demand for domestically produced substitute goods increases
e. real value of fixed assets increases
(52%) 8. Which of the following events will most likely cause an increase in both
the price level and real gross domestic product?
a. The prime rate increases.
b. Exports increase.
This would cause an increase in AD, incr PL and Y.
c. Income taxes increase.
d. Crude oil prices decrease.
e. Inflationary expectations decrease.
(57%) 9. If an economy’s AS curve is upward sloping, an increase
2005 APin government
Exam
spending will most likely result in a decrease in the
a. real output b. PL
c. interest rate
d. unemployment rate e. budget deficit
(47%) 10. An increase in which of the following will lead to lower inflation
and lower unemployment?
a. exports b. AD c. Labor productivity d. Government spending
[would lead to an increase in AS, lowering PL & unemployment]
(54%) 11. An unanticipated decrease in AD when the economy is in equilibrium will result in
a. a decrease in voluntary unemployment
b. a decrease in the natural rate of unemployment
c. a decrease in AS
d. an increase in unplanned inventories
e. an increase in the rate of inflation [with job loses, unsold inventory would stack up]
(34%) 12. Which of the following would be true if the actual rate of inflation were less
than the expected rate of inflation *Inflation is predicted to be 6% but is only 3%.
a. Inflation had been underpredicted. [No, it was overpredicted]
b. The real interest rate had exceeded the nominal interest rate.
c. The real interest rate had been negative.
d. People who borrowed funds at the nominal interest rate during this time period would lose.
Borrowers could get cheaper loans but they agreed to the higher loans.
AD/AS
Questions
2000
1. (58%)
A contractionary
supply From
shock would
mostAP
likelyExam
result in
a. an increase in AD
d. a decrease in the general price level
b. an increase in national income
e. a decrease in employment
c. an increase in GDP
SRAS would shift left, incr PL, decr GDP, & decr employment.
2. (82%) If the economy is operating in the intermediate range of the AS curve and
if AD increases due to an increase in net exports, then the price level, output, &
the unemployment rate are most likely to change in which of the following ways?
Price Level
Output
Unemployment Rate
a. increase
increase
increase
b. increase
increase
decrease
c. increase
decrease
increase
d. increase
decrease
decrease
e. decrease
decrease
increase
3. (78%) The short-run AS curve is likely to shift to the left when there is an increase in
a. the cost of productive resources
d. the federal budget deficit
b. productivity
e. imports
c. the money supply
4. (54%) Which of the following best explains how an economy could simultaneously
experience high inflation and high unemployment?
a. The government increases spending without increasing taxes.
b. The government increases taxes without increasing spending.
c. Inflationary expectations decline.
d. Women and teen-agers stay out of the labor force.
e. Negative supply shocks cause factor prices to increase
2000 AP Exam
5. (89%) The intersection of the AS & the AD curve occurs at the economy’s
equilibrium level of
a. real investment and the interest rate
d. government expenditures & taxes
b. real disposable income and unemployment e. imports and exports
c. real domestic output(GDP) and the price level
6. (58%) Which of the following would cause a rightward shift of the AS curve?
a. an increase in interest rates
b. a tax increase of 50 cents per gallon for gasoline
c. an across-the-board reduction of wages in the manufacturing sector
d. the passage of legislation mandating a reduction in automobile pollution
e. the shutdown of plants and movement of production of goods abroad
7. (38%) Which changes in the AD & AS curves is likely to result in stagflation?
a. the AD curve shifts to the left when the economy is in the classical range of the AS curve.
b. the AD curve shifts to the right when the economy is in the classical range of the AS curve.
c. the AD curve shifts to the right when the economy is in the Keynesian range of the AS curve.
d. The AS curve shifts to the left.
e. The AS curve shifts to the right.
2008 FR B
11 points: (2 + 2 + 2 + 3 + 2)
Assume that the economy of Country Z is operating on the upward-sloping portion of
its short-run aggregate supply curve. Assume that the government increases
spending.
 (a) How will the increase in government expenditures affect each of the following
in the short run?

(i) Aggregate demand

(ii) Short-run aggregate supply

(b) Using a correctly labeled graph of aggregate demand and aggregate supply,
show the effect of the increase in government expenditures on real output and the
price level.

(c) Assume that the government funded this increase in expenditure by borrowing
from the public. Using a correctly labeled graph of the loanable-funds market,
show the effect of the increase in government borrowing on the real interest rate.

(d) Given the change in the real interest rate in part (c), what will be the effect on
each of the following on the foreign exchange market?



(i) Supply of Country Z’s currency. Explain.
(ii) The value of Country Z’s currency
(e) Given your answer in part (d) (ii), what will be the effect of the change in the
value of Country Z’s currency on Country Z’s exports? Explain.
Answer:





(a) 2 points:

One point is earned for stating that the aggregate demand will
increase.

One point is earned for recognizing that the short-run aggregate
supply is not affected.
(b) 2 points:

One point is earned for a correctly labeled graph of aggregate
demand and aggregate supply.

One point is earned for showing a rightward shift of the
aggregate demand curve and showing an increase in both real
output and the price level.
(c) 2 points:

One point is earned for a correctly labeled graph of the
loanable-funds market.

One point is earned for showing a rightward shift of the demand
curve for funds and concluding that the real interest rate will rise.
(A leftward shift of the supply curve is accepted.)
(d) 3 points:

One point is earned for stating that the supply of Country Z’s
currency will decrease.

One point is earned for the explanation that the higher interest
rate reduces the outflow of funds to countries that now have a
relatively lower interest rate.

One point is earned for concluding that the value of Country Z’s
currency will rise or Country Z’s currency will appreciate.
(e) 2 points:

One point is earned for stating that Country Z’s exports will
decrease.

One point is earned for the explanation that the appreciating
currency makes Country Z’s goods relatively more expensive.
2006 FR 11 pts (3+2+2+3+1)
Assume that the US economy is currently operating at an
equilibrium below full employment.
A. Draw a correctly labeled graph of ADAS, and show each of
the following


Long Run Aggregate Supply
Current equilibrium output and price level
B. Now assume a significant increase in the world price of oil, a
major production input in for the US. Show on your graph in
part (a) how the increase in the oil price affects each fo the
following in the short run


Short Run Aggregate Supply
Real output and price level
C. Given your answer in part (b), explain what will happen to
unemployment in the US in the short run.
D. Assume the US trade with Japan, Draw a correctly labeled
graph of the foreign exchange market for the US dollar.
Based on your indicated change in real output in part (b)
show and explain how the supply of the US dollar will be
affected in the foreign exchange market.
E. Given your answer in part (d), indicated what will happen to
the US dollar relative to the Japanese yen
Answer:
a.
One point is earned for AS/AD
graph.
one point is earned for showing a
vertical LRAS
one point is earned for showing
current output and PL below full
employment
b.
One point is earned for showing a
leftward shift of the SRAS curve
one point is earned for showing
that real output falls and price level
rises.
c. One point is earned for stating that
unemployment increases
one point is earned for explaining
that the cause is the decrease in
real output
d.
One point is earned for a correctly
labeled graph
One point is earned for explaining
that the fall in real income will
cause the demand for imports to
decrease
One point is earned for showing
that the supply curve for dollars will
shift to the left
e. One point is earned for stating the US
dollar will appreciate.
Assume that the United States economy is in
long-run equilibrium with an expected
inflation rate of 6 percent and an
unemployment rate of 5 percent. The

Using a correctly
labeled
graphiswith
both the short-run and long-run
nominal
interest
rate
8
percent.
Phillips curves and the relevant numbers from above, show the
current long-run equilibrium as point A.

(b) Calculate the real interest rate in the long-run equilibrium.

(c) Assume now that the Federal Reserve decides to target an
inflation rate of 3 percent. What open-market operation should the
Federal Reserve undertake?
PL
Assume the economy is at full employment. If government
spending decreases, illustrate the effect on an appropriately
labeled AD-AS diagram on PL, output and unemployment.
Assume a LR adjustment on the AD-AS model if the economy is
left to adjust itself. Use an appropriately labeled SR Phillips curve
to illustrateAD-AS
the changes
in the SR. Use
Model in PL and unemployment
Inflation
an appropriately labeled LRPC to illustrate what
rate will happen to PL
ab
LRAS
in the long run.
%
SRAS1
SRAS2
a
%b
SRPC
ua
PL1
PL2
a
Inflation
rate
c
AD2
Y2 YF
LRPC
unemployment
rate
ac
%a
b
PL3
ub
AD1
GDPR
%c
UNRU
Unemployment
rate
Assume the economy is at full employment and government cuts
taxes. Using an appropriately labeled AD-AS model show the
effect of the tax cut in the short run and the long run (if nothing
else happens). Illustrate the changes in unemployment and PL
using a SRPC and the change in the LR using a LRPC
PL
PL3
SRAS2
SRAS1
LRAS
c
PL2
PL1
Inflation
rate
ab
%b
b
%a
SRPC
ub
a
ua
unemployment
rate
AD2
Inflation
rate
AD1
LRPC
ac
%c
%a
YF Y2
GDPR
UNRU
Unemployment
rate
1. The unemployment rate in the country of Southland is greater than the natural rate of unemployment.
(a) Using a correctly labeled graph of aggregate demand and aggregate supply,
show the current
equilibrium real gross domestic product, labeled YC, and
price level in Southland, labeled PLC.
The president of Southland is receiving advice from two economic advisers—Kohelis and Raymond—about how best
to reduce unemployment in Southland.
(b) Kohelis advises the president to decrease personal income taxes.
(i) How would such a decrease in taxes affect aggregate demand?
Explain.
(ii) Using a correctly labeled graph of the short-run Phillips curve, show the
effect of the decrease in taxes. Label the initial equilibrium from part (a)
as point A, and the new equilibrium resulting from the decrease in
taxes as point B.
(c) Raymond advises the president to take no policy action.
(i) What will happen to the short-run aggregate supply curve in the long
run? Explain.
(ii) Using a new correctly labeled graph of the short-run Phillips curve,
show the effect of the change in the short-run aggregate supply you
identified in part (c)(i).
LRAS
PL
SRAS
PLC
AD
YC
YF
GDPR
↓PIT→↑C→↑AD
Inflation
rate
B
%2
A
%1
SRPC
U2
U1
unemployment
rate
If they do nothing, then in the
LR suppliers will decrease
wages due to decrease in
profits, causing the SRAS to
increase because they will hire
more workers at a lower wage
and increase output
1.
The Unemployment rate is an important indicator of health of the
United State economy.
a)
Assume that with the economy at full employment, the government
implements an expansionary fiscal policy. How does the actual
unemployment rate at the new short run equilibrium compare with the
natural rate of unemployment?
b)
Assume that a significant number of workers are involuntarily changed
from full time to part time employment. Explain how this will affect the
number of people who are officially classified as unemployed.
c)
Assume that the government reduces the level of unemployment
compensation.
i.
Explain how his affects the natural rate of unemployment
ii.
Using a correctly labeled graph, show how this affects the long-run Phillips
curve.
Period
Unemployment rate
Inflation rate
Last year
2%
8%
This year
5%
4%
1. Draw a correctly labeled graph of a short run Phillips curve for Country
X, showing the actual unemployment and inflation rates for both years.
Label the Phillips curve as SRPC
2. Now assume that the short run aggregate supply curve has shifted to
the left
a) Identify one factor that could cause this aggregate supply shift
b) On the graph, show how this shift would affect the short run Phillips
curve
3. Assume that the natural rate of unemployment in Country X is 5%.
Draw a correctly labeled graph of the Long run Phillips Curve and label
it LRPC
4. What is relationship between unemployment rate and the inflation rate
in the long run
Assume the economy is at full employment and government increases
government spending. Using an appropriately labeled AD-AS model show
the effect of the government spending in the short run and the long run (if
nothing else happens). Illustrate the changes in unemployment and PL using
a SRPC and the change in the LR using a LRPC
PL
PL3
SRAS2
SRAS1
LRAS
c
PL2
PL1
Inflation
rate
ab
%b
b
%a
SRPC
ub
a
ua
unemployment
rate
AD2
Inflation
rate
AD1
LRPC
ac
%c
%a
YF Y2
GDPR
UNRU
Unemployment
rate