Aggregate Demand/Supply Flashcards
Why is the AD/S model necessary over the Aggregate Expenditure Model?
The Keynesian model only outlines the impact of a change in spending on output - nothing about changing expenditure on the general price level.
Only focuses on the demand side - disregards fields such as labour force, capital stock, tech level and productivity.
What is Aggregate Demand?
The total amount of spending in an economy.
The AD curve - relationship between price level and quantity of output demanded (C,I,G,X-M).
What is Aggregate Supply?
The relationship between the total production of g+s and general price level.
What are the two types of Aggregate supply curves?
LRAS - Vertical (max. level of output).
- determined by size of economy’s work force, capital and state of technology.
SRAS - Diagonal (As EGR rises, so do price levels).
- increase production - firms require more labour/capital, pressures resource prces - wages rise, causing the general pricel level to rise - approaching full capacity/full employment.
Outline the shifts of the two AS curves.
Positive AS curve:
- Increase in nowledge/tech - rise in abour force - reduce production costs - SRAS curve shifts right - level of real GDP and employment rises.
Negative AS curve:
- Increase in price of certain input (oil) - increase production costs - shift SRAS to the left - level of real GDP and employment will fall.
What are contractionary/expansionary gaps; how are they visible on the model?
Contactionary:
- Low inflation, spare capacity of the economy. High levels of cyclical UE, drop in LF (less chance of finding a job), lower company profits, slower growth in consumer expenditure, low interest rates, need for social security, reduction of sales of consumer durables, CAD falls if I drops > savings.
- Short run equilibrium is below Yp - AD intersects SRAS to the left of LRAS.
Expansionary:
- Higher rates of wage inflation, low levels of cyclical UE, increase in LF, rise in company profits/business confidence, rise in consumer confidence, reduced need for gov welfare, CAD rises if I rises > savings.
- Short run equilibrium is above Yp - AD intersects SRAS to the right of LRAS.
How does the AD/AS model relate to the business cycle?
Assume the economy is in long run equilibrium at potential GDP. AD/SRAS match to Yp.
Negative AD shock:
- AD drops; cut productio so Y and employment will fall.
- Real output falls - reduced inflationary pressure sees price inflation fall.
Negative AS shock:
- Contraction - rise in oil proces.
- level of output falls; prices rise - events cause production costs to rise.
- Stagflation (lower growth) - prices are rising due to higher costs.
What are the factors impacting the Negative AD curve?
Negative Relationship: AD shifts to the left.
- Income/wealth effect.
- Interest Rate effect.
- Open economy effect.
1) Price levels increase, leading to lower purchasing power of households; y falls.
2) H/F demand more funds - withdrawing/borrow $ from banks or sell financial assets such as bonds. Rise in demand for $ increases interest rates - rise in cost of borrowing.
3) Inflation rises relative to other countries - H/F invest overseas - spending on M rises - Net exports (X-M) falls.
What are the factors impacting the Positive AD curve?
- Rise in consumer confidence will increase household consumption - AD shifts to the right.
Caused by a rise in share prices/fall in interest rates.
Outline Macroeconomic Equilibrium of AD/AS model.
The economy is in long run macroeconomic equilibrium when AD & SRAS curves intersect ate YP (potential level of output).
Unemployment is at a natural state.
A shift in AD/SRAS curve will cause short run equilibrium to diverge from long run equilibrium.
