Transcript AD/AS Equilibrium

Unit 3:
Aggregate Demand and
Supply and Fiscal Policy
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Shifters of Aggregate Demand
AD = C + I + G + X
Change in Consumer Spending
Change in Government Spending
Change in Investment Spending
Net EXport Spending
Shifters of Aggregate Supply
AS = I + R + A + P
Change in
Change in
Change in
Change in
Inflationary Expectations
Resource Prices
Actions of the Government
Productivity (Investment)
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Practice
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Answer and identify shifter:
C.I.G.X or
I.R.A.P
B
A
D
A
D
B
A
A
C
A
A major increase in productivity.
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Putting AD and AS together to get
Equilibrium Price Level and Output
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Inflationary and
Recessionary Gaps
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Example: Assume the government increases
spending. What happens to PL and Output?
Price
Level
LRAS
AS
PL and Q will
Increase
PL1
PLe
AD
QY Q1
AD1
GDPR
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Inflationary Gap
Output is high and unemployment is less than NRU
LRAS
Price
Level
AS
Actual GDP
above potential
GDP
PL1
AD1
QY Q1
GDPR
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Example: Assume the price of oil increases
drastically. What happens to PL and Output?
Price
Level
LRAS
AS1
AS
PL1
Stagflation
PLe
Stagnate Economy
+ Inflation
AD
Q1 QY
GDPR
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Recessionary Gap
Output low and unemployment is more than NRU
LRAS AS1
Price
Level
Actual GDP
below potential
GDP
PL1
AD
Q1 QY
GDPR
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AD and AS Practice
Worksheet
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How does this cartoon relate to Aggregate Demand?
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Draw AD and AS at full employment
Price Level
LRAS
AS
P2
P1
AD2
AD=C+I+G+X
Qf Q2
(Y*or FE)
Output Increases
GDPR
PL Increases
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Short Run and
Long Run
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Shifts in AD or AS change the price level and
output in the short run
Price
Level
LRAS
AS
PLe
AD
QY
GDPR
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Example: Assume consumers increase
spending. What happens to PL and Output?
Price
Level
LRAS
AS
PL1
PLe
AD
QY Q1
AD1
GDPR
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Now, what will happen in the LONG RUN?
Inflation means workers seek higher wages and
production costs increase
LRAS AS1
Price
Level
AS
PL2
Back to full
employment with
higher price level
PL1
PLe
AD
QY Q1
AD1
GDPR
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Example: Consumer expectations fall and
consumer spending plummets. What happens to PL
and Output in the Short Run and Long Run?
Price
Level
LRAS
AS
AS1
AS increases as
workers accept lower
wages and production
costs fall
PLe
PL1
PL2
AD1
Q1 QY
AD
GDPR
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The Ratchet Effect
A ratchet (socket wrench)
permits one to crank a
tool forward but not backward.
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Does deflation (falling prices) often occur?
Not as often as inflation. Why?
• If prices were to fall, the cost of resources must
fall or firms would go out of business.
• The cost of resources (especially labor) rarely fall
because:
• Labor Contracts (Unions)
• Wage decrease results in poor worker morale.
• Firms must pay to change prices (ex: repricing items in inventory, advertising new
prices to consumers, etc.)
Like a ratchet, prices can easily move
up but not down!
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