Aggregate Demand, Supply and the Price Level Flashcards
What is aggregate demand?
Total demand of final goods
Why is aggregate demand downward sloping?
Because of income and substitution effect
What is income effect?
If price increases, you can buy less the same amount of income
What is the substitution effect?
If prices increase, you are going to substitute the more expensive product with a relatively cheaper one
What are the determinants of AD?
Price level, income, expectations, government spending and international trade
What does a change in price level cause for the AD curve?
A movement along the AD curve, any other changes will shift it
What is aggregate supply?
Produced within a certain period of time
What happens to the AS in the short-run?
Upward sloping
What happens to the AS in the long-run?
Vertical
What are the determinants of AS?
Price level, technology, quantity and quality of production factors and expectations
What does a change in price level cause for the AS curve?
A movement along the AS curve, any other changes will shift it
When does the equilibrium occur in the short-term?
Occurs when AD and AS intersect
What happens if prices are higher than PL on the graph?
It would lead to excess supply, which would lower the price level
What happen if prices are lower than PL on the graph?
It would lead to excess demand, which would increase the price level
What is the effect of an increase in AD?
AD shifts to the right, which increase price level and output
What is the effect of a decrease in AS?
AS shifts to the left, which increases price level and decreases output
What happens in the long-run in AS?
LRAS is vertical, Y is constant and only the price level can change, labour market can return to the long-run equilibrium easily and wages are flexible
What policies influence the equilibrium level of the economy?
Demand-side and supply-side policies
What are demand-side policies?
They influence the level of aggregate demand (C+I+G+NX)
What are supply-side policies?
They influence the aggregate supply
What is the aim of supply-side policies?
To shift (increase) to the LRAS to the right
What are examples of supply-side policies?
Labour market measures, capital goods, encouraging competition, changing regulations and improving infrastructure
What are the difficulties of supply-side policies?
Only valuable if there is a demand, flexibility in the labour market leads to more insecurity and gap between rich and poor might increase, if unemployed become worse off
What are the different views on AS?
Classical and Keynesian
What is classical?
When wages are very flexible (including downwards) - economy reaches its potential output quickly
What is Keynesian?
When wages are sticky (especially downward) - economy would be stuck below potential output and the AS would be very elastic (horizontal)
