Week 8 - AS-AD Model Flashcards
What is Say’s Law
Classical economists clam that whatever is produces would be consumed (mainly due to the circular flow)
What does Keynes say about Say’s Law
Keynes argues that supply is largely driven by the expected extent of future demand, if suppliers mis estimate future AD it is possible some output may be unconsumed
What does the as-ad model do?
Attempts to explain short-run fluctuations in real GDP and the price level. The AD curve shows the price level and quantity of real gdp demanded in the economy (AS shows this supplied). This relationship between nominal prices and real output violates the classical dichotomy.
Why does the As-ad model violate the classical dicothomy>
There is a relationship between nominal prices and real output. It is a short-run model where lags and rigidities in adjustment lead to nominal quantities having real effects
Factors that mead the demand curve has a negative slope?
1) wealth effect (change in price level affects real wealth and consumption)
2) interest rate effect (change in price level affects real interest rate and investment)
3) international trade effect (change in price level impacts relative price of foreign and domestic goods and net exports)
What does a movement along the AD curve show
a movement holds everything constant and shows what real GDP will be given different possible price levels as driven by the components of AE and how these are affected by prices
Impact of higher interest rates on AD
shift to the left as cost of borrowing rises, reducing C and I
Impact of higher gov purchases on AD
Shift to the right as G is a component of AD
Impact of higher taxes on AD
shift to the left as C falls with higher income tax and I falls with companty tax
Impact of better household income expectations on ADq
Shift to the right as consumption increases
Impact of better firm expectations of profitability on AD
Shift to the right as investment increases as they believe it will be more profitable
Impact of higher relative domestic growth on AD
Shift to the left as exports fall
Impact of a higher exchange rate on AD
Shift to the left as imports increase and exports fall
What can shift the long run aggregate supply curve?
Vertical line at potential GDP can shift with the labour force, amount of machinery and equipment or technology
Why is the SRAS upwards sloping?
firms produce more in response to higher prices. This is because input prices typically rise slower than final prices (due to sticky wages and prices, firms being slow to adjust wages and menu costs)
What is the money illustion
People misread inflation in the short run leading to a temporary illusion as to the real value of money. Firms will invest more if they think inflation is lower
Why are wages sticky and relationship to output?
contracts and social conventions.
If actual inflation is less than expected, output falls as real wages are higher. Inflation is associated with higher output.
Why are prices stick and relationship to output?
Some goods have long-term contracts or complex pricing schemes. If inflation is higher than expected, real prices are lower stimulating demand and output.
Impact of higher labour force or capital stock on AS
Shift to the right as more output can be produced at each price level (same for resources)
Impact of higher productivity on AS
Shift to the right as costs of producing each unity of output falls
Impact of higher expected future price level on AS
shift to the left as costs of producing rise
Impact of workers/firms adjusting to previously underestimated price level?
Shift to the left a workers are firms increase wages and prices
Impact of higher expected price of an important natural resource
Shift to the left as costs of producing increase
What is equilibrium in the AD-AS model
place where LRAS, SRAS and AD intercept. Actual output is equal to LR potential output and there if full employment and no underutilised capacity.
Neo classical and Keynes aspects of AS-AD model
Assumed long run equilibrium will always hold (NC) but short run deviations possible (K)
Money is neutral in long run (NC) but nor in short run (K)
Both supply and demand determine output (K) but only supply determines long run output (NC)
Economic agent expectations have short run implications for output and prices (K) but not in long run (NC)
What is the y intercept in the Ae model
autonomous consumption
Difference between micro demand and aggregate demand
Micro demand relates to the willingness to pay for an individual good from individual curves. AD relates to AE and the price level on an economy wide level
Why is SRAS sloping
money is not neutral in the short run. Higher prices mean firms tend to produce more as they receive more (wages and capital are sticky). In the long-run, firms must adjust these and producing more or less won’t change anything
Difference between micro and aggregate supply
From the micro point of view, supply is the marginal cost curve rather than relating to the price of L and K
Define demand inflation
higher demand result in a rightwards shift in AD. This results in higher inflation and higher output. E.g. the mining boom
Define cost inflation
Higher production costs lead to SRAS shifting left, higher inflation and lower output.
