Unit 3: The AS/AD Model

March 9, 2018

The AS/AD Model

• The equilibrium of AS and AD determines current output (GDPR) and the price level (PL).

• Full Employment
• Full Employment equilibrium exists where AD intersects SRAS and LRAS at the same point.
• Recessionary Gap
• A recessionary gap exists when equilibrium occurs below full employment output.
• Inflationary Gap
• A inflationary gap exists when equilibrium occurs beyond employment output.

Changes (  ⃤  ) in AD

• ⃤⃤⃤   Consumption (C)
• ⃤⃤   Gross Private Investment (Ig)
• ⃤⃤⃤⃤   Government Spending (G)
• ⃤   Net Exports (Xn)

• Increase in AD

• Decrease in AD

Changes (  ⃤  ) in SRAS

• ⃤⃤   input prices
• ⃤   Productivity
• ⃤   Legal - Institutional Environment

• Increase in SRAS

• Decrease in SRAS

Three Ranges of Aggregate Supply

• Horizontal or Keynesian Range
• Lot of unemployed resources
• a recession of depression can occur
• includes only levels of real output that are less than the full-employment output
• Intermediate Range
• Resources are getting closer to the full-employment level which creates upward pressure on wages and price
• Vertical or Classical Range
• When real GDO is at a level with unemployment below the full employment level and where any increase in demand will result in only an increase in price
• The economy is unable to produce anymore goods and services for a sustainable period of time.