week 7 Flashcards
what are the AS classical model views?
wages and prices are fully flexible
▶ Adjustment to shocks is instantaneous ensuring that markets clear to maintain full
employment with the economy always at potential output
▶ Any deviation of actual output from potential output causes instantaneous price and wage
changes to restore output to potential output
▶ Supply side of the economy determines output i.e. real income
▶ Demand side of the economy determines inflation
what are the views of the AS keynesian model?
wages and prices are inflexible in the short-run
▶ Adjustment to shocks is not instantaneous and actual output may deviate from potential
output
▶ In the short-run, AD and AS jointly determine inflation and output
▶ In the long-run, prices adjust fully and output is determined only by AS
▶ The Keynesian model of inflexible wages and prices may describe the economy before
adjustment is complete
what can the classical view of AS help to explain?
explains fluctuations in economic activity and how economic
agents respond to economic events
▶ Introduces a significant role for the supply side of the economy
▶ Helps us to understand the long-run process of economic growth
▶ Provides a basis for understanding movements in the price level i.e. the inflation rate
in the classical model of AS output is unaffected by inflation how is this?
Wage and price flexibility ensures that nominal and real variables change together and by the
same proportion
this means inflation has no impact on firms.
in the classical model potential output depends on?
▶ The quantities of available inputs to the production process
▶ The level of technology or efficiency with which available resources are used
what is the relationship with inflation and Aggregate demand
▶ It reveals an inverse relationship between aggregate demand AD and inflation
what do movements along the AD line show?
how inflation makes the Central Bank change nominal interest rates and thus AD
▶ Higher inflation results in higher nominal interest rates and hence a reduced level of investment and aggregate demand AD
what does incorporating a Keynesian view into the price ASAD model allow for?
results in opportunities for output to diverge from potential output in the short-run
eg - nominal wages may take time to adjust, firms may vary labour input and thereby affect output
what does the SRAS show ?
shows the level of output firms are willing to supply at each inflation rate, given the real wage growth they face in the short-run
what does aggregate supply depict?
the classical view
what does short run aggregate supply depict?
depicts keynesian position
what causes SRAS to shift?
changes in nominal wage growth
what will happen to output and supply if there is a temporary supply shock?
potential output in unaffected
SRAS is affected by the rate of nominal wage growth and the growth of other input prices like energy
a negative supply shock shifts SRAS upwards to SRAS
what would happen to output and supply if there was a permanent supply shock
shifts output to the right and also shifts supply to the right as well increase in output and inflation
