Unit III: AD and AS

The Start of Unit III.. 

the basics: AD and AS

  
Aggregate Demand (AD)
-Shows the amount of Real GDP that the private, public, and foreign sector collectively desire to purchase at each possible price level
-The relationship between the price level and the level of Real GDP is inverse

3 Reasons why AD is downward sloping
-Real-Balances Effect

• When the price level is high, house holds and businesses cannot afford to purchase as much output
• When the price level is low, households and businesses can afford to purchase more output

-Interest Rate Effect

• A higher price level increases the interest rate which tends to discourage investment
• A lower price level decreases the interest rate which tends to encourage investment

-Foreign Purchases Effect

• A higher price level increases the demdn for relatively cheaper imports
• A lower price level increases the foreign demand for relatively cheaper U.S. exports

Shifts in AD
-2 parts to a shift in AD=
 *A change un C, IG, G, and Xn
 *A multiplier effect that produces a greater change in the four components
-Increases in AD=AD shifting right
-Decreases in AD=AD shifting left
-Government spending
*More causes AD to shift right
*Less causes AD to shift to the left


Aggregate Supply
-The level of Real GDP (GDPr) that firms will produce at each price level (PL)

Long Run vs. Short Run
-LRAS
*Period of time where input prices are completely flexible and adjust to changes in the PL   
*The level of GDPr supplied is independent of the PL
-SRAS
*Period of time where input prices are sticky and do not adjust to change in PL
*The level of GDPr supplied is directly related to the PL

Long Run Aggregate Supply (LRAS) 
-The LRAS marks the level of FE in the economy (analogous to PPC)
-LRAS=Vertical at full employment


Short Run Aggregate Supply (SRAS)
-Upward sloping


Changes in SRAS
-Increase in SRAS=Shft right
-Decrease in SRAS=Shift left
-The key to understanding shifts in SRAS is per unit cost of production
Per unit production cost = Total input/Total output

Determinants of SRAS (all of the following affect unit production cost)
-Input prices
*Increases in resource prices=SRAS shift left
*Decreases in resource prices=SRAS shift right
-Productivity
*Ex. Technology
*=Total output/total input
*More productivity=lower unit production cost=SRAS shift right
*Lower productivity=higher unit production cost=SRAS shift left

Ranges/Shapes/Views of AS


-Keynesian Range
*Believe in a horizontal curve because when the economy is below full employment, AD shifts outward (increase in GDPr and unemployment drops and price level remains constant
*Demand creates its own supply

-Intermediate Range
*AS is between the Key. and Classical ranges
*When this occurs, GDP and PL increases

-Classical Range
*Say's Law
*In the long run, the AS curve is vertical because the only effects of an increase in AS when we are already at FE. Thus supply creates its own demand