Dean Essay Question Flashcards
AD - AS Model allows us to…
take CFM a step further
CFM limitations?
assumes firms can readily change output decisions in response to change in AD - not always true esp if already working at max capacity
No price consideration/ inflation free
Changes in AD key to explaining volatility but not always. So we need AD - AS model to show…
fluctuations from the supply side too e.g. rise in oil prices
AD curve shows…
relationship between total demand for resident firms goods/services and the economy’s average price level
AD curve is downward sloping because…
it reflects the negative relationship between AD and GDP deflator
We expect AD to decrease as Price increases (LAW OF DEMAND). This can be due to which effects?
Income effect: Increase in P will cause this cos nominal salary = fixed = fall in purchasing power = fall in real income
Substitution effect: people switching from spending to saving (uncertain times) = LESS CONSUMPTION
P increase X drop M increase = fall in AD
Interest rate effect: Need liquidity due to high prices but not enough money in bank so interest rates up to discourage lending and spending
ALL OF THIS LEADS TO REDUCED CONSUMPTION AND INVESTMENT
Weaker the effects…
the steeper the curve
Stronger the effects…
the more elastic the curve
Change in any components other than PRICES cause curve to …
shift either to right or left depending on type of shock
Curve is constantly shifting because…
economy is dynamic and volatile, experiences business cycles
