AD/AS model Flashcards
Main macro objectives
- price stability
- growth
- unemployment
- external equilibrium
Aggregate demand = ?
Consumer index + Government expenditure + Investment + (Exports-Imports)
Aggregate demand definition
total quantity of goods and services that all buyers in an economy want to buy over a period of time. cet par.
AD curve
shows relationship between total amount of real output demanded and average price level over a period of time.
AD downward shape effects:
- Wealth affect: APL rises, real value of money & assets decrease = people feeling poorer, output falls
- Interest effect: APL rises, people might increase demand for borrowing
- Trade effect: APL rises, exports become less competitive
shifts in AD curve
- fiscal policy
- monetary policy
- foreign incomes
- expectations
- external shocks
shift in AD curve
fiscal policy
gov. policy of changing G &/or T in order to affect macro economy.
i) Expansion policy - cause AD to shift to the right (increasing G & decreasing T)
ii) Contractionary policy - shift AD to left (decreasing G & increasing T)
shift in AD
monetary policy
aims to influence interest rate & money supply.
Shift in AD
foreign incomes
- if FIs rise, DD for exports rise = AD shift to the right (&visa versa)
- exchange rate changes = the price of exports & imports affected, X falls = AD shift to right
*only if Marshal Lerner criteria is applied = PED of imports = PED of exports
shift in AD
expectations
if it is expected prices will rise = AD may increase
shift in AD
external shocks
e.g. wars, disasters, cold winters
CAUSES
what does not cause a shift in AD
APL or rGDP does not cause a shift in AD. these cause a movement along the curve
details of shift in AD by component
consumption expenditure (C)
Consumer demand =f(CC, IR, W, PiT, HI)
- consumer confidence CC
- level of optimism or pessimism regarding future incomes
- can cause C to decrease shifting AD left
- measured by an index - changes in interest rates IR
- a rise in rates = C to fall
- may also cause savings to increase due to it being more attractive, decreasing C causing AD shift left - wealth effect W
- an increase in value of assets can increase C & decrease savings as people feel wealthier - shift AD to the right - personal income tax PiT
- PiT affects disposable income after tax - household debt or indebtedness HI
- if household debt is high, C can fall causing AD to fall.
details of shift in AD by component
investment expenditure (I)
business demand, I=f(IR, BC, Tech, BT, CD, legal/institutional changes)
- interest rates
rising IR makes financing capital goods more expensive therefore investment projects are less affordable - business confidence BC
impacted by economic and political stability - tech
changes in technology, firms can be forced to invest to keep up with competitors
4.business tax BT
taxes on profits affect profitablility of investments - affects investment levels
- company debt levels CD
businesses that are highly indebted will be reluctant to take on more debt “I” will fall & AD will shift left - legal and institutional change
e.g. no access to credit, lack of property rights, corruption
details of shift in AD by component
net exports
(X-M)
- changes in foreign incomes
- can reduce demand for exports and reduce (X-M) & shift AD left - change in exchange rates
- if ER depreciates, exports become more competitive - exports should increase= X-M rises and AD shifts to the right.
- opposite will happen when ER appreciates - changes in trade protection levels
- e.g. reduce in tariffs on exports or reducing quotas will likely reduce exports (X-M) rising = AD shift right
aggregate supply definition
total quantity of g&s produced in an economy over a period of time
aggregate supply
Short run aggregate supply
SRAS
shows the relationship between the price level & rGDP produced by firms
Shape of SRAS
positive relationship between PL & output. i.e it slopes upwards.
as PL rises, output prices are increasing BUT FoP’s are not
Long run aggregate supply
LRAS
prices of g&s rise AND fop prices rise AND unployment rise at the natural rate + representing long run potential output
Aggregate supply, shifts in AS
Factors for both SRAS & LRAS
- capital investment, quantity & quality
- labour, quantity & quality
- supply side policies
- legislation
Aggregate supply, shifts in AS
ONLY SRAS
- change in fop prices
- increase in fop prices causes SRAS to shift to the left
- increases/decreases in labour
- changes in exchange rate
- LRAS is not affected bcause all prices change equally in the long run - i.e if prices of price of g&s increases price of fops increase by the same in the LR - weather/disease/war
- both affect SRAS in the case of agriculture
- effectively increase cost of production & therefore shift SRAS to the left (& visa versa)
- might afect labour because of working conditions
- i.e. SUPPLY SHOCKS
- wars can also supply side shock, increasing cost of production in different sectors
factors that will shift AS
a shift in LRAS will cause an equal shift in SRAS
- capital
- more machines, better tech - increase the productivity of labour & therefore shift AS to the right - Labour
- increase in quantity (migration & increased participation by women)
- increase in quality (better training, education, health). - supply side policies
- changes in legislation e.g. retirement age, school leaving age
shift in AS
supply side policies
- reduce income taxes to provide a greater incentive to work
- reduced unemployment benefits
- reduce the power of trade unions in order to reduce barganing power
- make it easier for firms to hire & fire
- policies aimed at improving education & training
- . encourage privatization (encourage efficiency & competition)
neo-classical economist
believe that if a recessionary gap or inflationary gap exists, tend to automatically be eliminated
keynsian economist
believes that an economy will not always self-correct and return to the full employment level of output
