AD/AS Flashcards
What do Keynesian and classical economists agree about the AD curve?
In the short run, the AD curve is downward sloping
Where is the equilibrium level of output (short run)?
It occurs at the intersection of the AD and AS curves. (Diagram on notion)
How does an increase in AD shift the curve?
An increase in AD shifts the curve to the right
- Fall in exchange rate - increase volume of exports and decrease imports
- Lowering of income tax - increase consumption as consumers have higher disposable income
- Falling interest rates - will increase consumption and investment
How will an increase in the components of AD affect the curve?
Shift the curve to the right as an increase will increase the AD
Diagram for rise of AD in the short run
On notion
What does a rise in AD increase?
A rise on AD increases both real output and the price level in the short run
What does a decrease in the components of AD mean and how will it affect the curve
It will decrease overall AD and shift the curve to the left
What does a fall in AD lead to a fall in?
Both a fall in real output and the price level
How does a fall in SRAS in the short run shift the curve?
It shifts the curve to the left and up
What are some of the factors that can cause a decrease in SRAS in the short run?
- Total wages of workers might rise
- Raw material prices may rise
- Taxes on goods and services might rise
Diagram for a fall in SRAS in the short run?
Check notion
Describe the fall in SRAS in the short run
Shifts from SRAS 1 to SRAS 2
Equilibrium output then falls from Y1 to Y2. At the same time, the price level rises from P1 to P2
What does a fall in the SRAS in the short run cause?
A fall in SRAS therefore leads to a fall in output but a rise in the price level in the short run
How does a rise in SRAS in the short run shift the curve?
It shifts the curve to the right and downwards
What are some of the factors that can cause an increase in SRAS in the short run
Total wages paid may decrease
Raw material prices may go down
Taxes on goods and services might fall
Subsidies as they allow for production costs to decrease
What does a rise in SRAS in the short run cause?
A rise in SRAS will lead to a rise in equilibrium output and a fall in the price level
Where is the equilibrium level of output (long run)?
It occurs at the intersection of the LRAS curve and the AD curve
Diagram for equilibrium output
Check notion
How does an increase in AD affect the AD curve
It shifts to the right
What determines a shift in the AD curve?
A change in the determinant of aggregate demand
CIGX-M
What does the LRAS curve show (classical economics)?
It shows the supply curve for the economy at full employment. They believe that when the market is in disequilibrium it corrects itself quickly
Diagram for a rise in AD (classical model)
Check notion
Describe the rise in AD in the classical model
AD curve shifts upwards from AD1 to AD2.
The equilibrium price level rises from P1 to P2 but equilibrium real output remains the same at Q
What does a rise in AD lead to?
A rise in the price level but no change in real output in the long run
Purely inflationary rise in PL as there is no increase in output
What does the LRAS curve look like (Keynesian economics)?
Check notion
What does this show?
The economy is at full employment where the curve is vertical but can be in disequilibrium, less than full employment, and in recession when horizontal
Diagram for a rise in AD (Keynesian)
Check notion it looks bare tapped
Describe the rise in AD in the Keynesian model
The AD curve rises along the LRAS curve
Goes sideways until the LRAS curve us straight and then it goes upwards
What does a rise in AD lead to?
It could lead to many things depending on where the increase is
From AD1 to AD2 will increase the equilibrium output from Y1 to Y2 without raising the price
From AD3 to AD4 will increase both equilibrium output and equilibrium prices - demand pull inflation
AD4 to AD5 will only be an increase in the price level and no change in real output, purely inflationary
What is the point of disagreement between the two economic ideas of the LRAS curve?
The extent to which workers will react to unemployment by accepting real wage cuts
What do classical economists argue?
A rise in unemployment will lead to cuts in real wages
These cuts will increase the quantity demanded of labour and reduce the quantity supplied, returning the economy to full employment quickly and automatically
What do Keynesian economists argue?
They argue that wages are sticky downwards
Workers will refuse to make wage cuts and will fiercely resist cuts in their real wage
The labour market will therefore not clear except perhaps over a very long period of time
What does a rise in LRAS mean?
It means that the potential output of the economy has increased
What might cause a rise in LRAS
Increased incentive to work
Improvements in technology
Diagram for a rise in LRAS (classical model)
Check notion
Describe the rise in LRAS in the classical model
A shift in the AS curve from LRAS1 to LRAS2 will increase equilibrium output from Y1 to Y2. Equilibrium prices will also fall from P1 to P2
What does a rise in LRAS lead to? (Classical)
Higher output and lower prices
Diagram for rise in LRAS (Keynesian)
Check notion
Describe the rise in LRAS in the Keynesian model
A shift in the aggregate supply curve from LRAS1 to LRAS2 increases full employment equilibrium output from YE to YF.
If the economy is at slightly less than full employment, with an aggregate demand curve of AD2, then the shift to the right in the LRAS curve will still be beneficial to the economy, increasing output and reducing prices.
If the aggregate demand curve is AD3, an increase in aggregate supply has no effect on equilibrium output. It remains obstinately stuck at YD.
What does a rise in LRAS lead to Keynesian?
It will increase output and reduce prices if the economy is at full employment
