AD-AS Model

Question 1

Aggregate demand

Equation

Answer 1

Y-Y(star)=-alphaxgamma(pi-pi*)+demand shocks

Question 2

Relationship between inflation, interest rates and output for aggregate demand

Answer 2

As inflation increases, central banks interest rate increases and output decreases
1. Keynesian model - relationship between Y and r
2. Monetary policy reaction function - relationship between pi and r

Question 3

Aggregate Supply Function

Answer 3

pi=pi(e) + thetaxbeta(Y-Y(star))

Question 4

Relationship between inflation, unemployment and output for aggregate supply

Answer 4

As inflation decreases, unemployment increases and output decreases

Question 5

LRAD and LRAS vs SRAD and SRAS graphically

Answer 5

SRAS + SRAD are normal - AS sloped up, AD down
LRAD - same as short-run
LRAS - vertical line at Y*

Axis titles are vertical = infaltion, horizontal = output

Question 6

Difference between demand and supply shocks

Answer 6

Demand: shocks drive inflation and output in the same direction
Supply: shocks drive inflation and output in opposite directions
(think about it GRAPHICALLY!!)

Question 7

What do the slopes of the AD and AS curves tell us?

Answer 7

The degree of response of inflation and output
e.g. if AD curve is flat, most of the response is a change in output with a little change in inflation

Question 8

What are permanent shocks to the AD and AS curves?

Answer 8

1. Shocks to Y* - impacts both AD and AS curves
2. Disinflation - AD curve shits and AS curve shifts until inflation expectation adjust and this, no LRAS change