AD-AS study guide PDF PDF

Preview

Summary

Summary of AD-AS by instructor...

Description

AD-AS Study Guide

AD-AS is a model mainly of output and prices. We’ll assume R to be fixed unless it’s explicitly changed. What’s crucial is that we are not fixing prices, unlike any of the other models we’ve done . The model has a few main features to know: AD : Aggregate Demand • The amount of output demanded by households at any price level • Slopes downward due to wealth effect, interest rate effect, and trade effect. • MOVES if there is a change in an exogenous part of spending: Government spending , Investment, Consumption, Exports, etc. • Keep in mind: if interest rates are changed, C and I will change too! Changes will show up in the intercept term. • • Goes RIGHT if there is an increase in the spending. • Goes LEFT if there is a decrease in spending. AS : Aggregate Supply • The amount of output supplied at any price level • Slopes upward due to sticky wages • MOVES if there is a change in the ability of the economy to produce goods, or a change in costs of production. • Changes will show up in the intercept term. • Goes RIGHT if there is an increase ability to produce, lower costs • Goes LEFT if there is a decrease in ability to produce, higher costs Equilibrium Price and Quantity: Where AD and AS intersect. Or, if we have the equations, we set them equal to one another.

Price Level

AS

P1

AD

Y1

Y

Example: Suppose that AD = 40,000 - 200P - 400 R and AS = 10,000 + 200 P. The Fed has set R=5. What is equilibrium price and quantity? 40,000 -200P -400*5 = 10,000 + 200P 28,000 = 400 P P= 70 Y = 10,000+200*70 = 10,000 + 14,000 = 24,000 Example: Suppose that in the economy above, the Fed raises R to 10. What is the effect on Y and P? 40,000 -200P -400*10 = 10,000 + 200P 36,000 -200P= 10,000 + 200P 26,000 = 400P P=65 Y= 10,000+ 20*65 = 23,000. P falls by 5, Y falls by 1,000

Example: Suppose that in the economy above, there is a natural disaster that knocks down many factories, so that AS = 5,000 + 200P now. What is the new Y and P? 40,000 -200P -400*5 = 5,000 + 200P 33,000 = 400 P P= 82.5 Y = 5,000+200*82.5 = 21,500 The general results: AS shifts left —-> P goes up, Y goes down. AS shifts right —-> P goes down, Y goes up. AD shifts right —-> P goes up , Y goes up AD shifts left ——> P goes down, Y goes down Graphs of this on the next page:

AD shifts left: AS

P

P1 P2

AD1 AD2 Y2

Y1

Y

AD shifts right: AS

P

P2 P1

AD2 AD1 Y1

Y2

Y

AS shifts right: AS 1

P

AS 2

P1 P2

!

! AD1 Y1

Y2

Y

AS shifts left:

AS 2

P

AS 1

P2 P1

AD1 Y2

Y1

Y...