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Understanding AS/AD Model for Macroeconomic Analysis

Dive into the AS/AD model equilibrium determining output and price level, explore gaps like recessionary and inflationary, learn about changes in AD impacting GDP and inflation, study SRAS changes affecting price level, and grasp the impact of supply shock on "stagflation."

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Understanding AS/AD Model for Macroeconomic Analysis

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  1. AP Macroeconomics The AS/AD Model

  2. The AS/AD Model • The equilibrium of AS & AD determines current output (GDPR) and the price level (PL) LRAS SRAS PL P AD YF GDPR

  3. Full Employment • Full Employment equilibrium exists where AD intersects SRAS & LRAS at the same point. LRAS SRAS PL P AD YF GDPR

  4. Recessionary Gap • A recessionary gap exists when equilibrium occurs below full employment output. SRAS LRAS PL P AD Y YF GDPR

  5. Inflationary Gap • An inflationary gap exists when equilibrium occurs beyond full employment output. LRAS SRAS PL P AD YF Y GDPR

  6. Changes (Δ)in AD • Δ Consumption (C) • C↑ .: AD  .: GDPR↑ & PL↑ .: u%↓ & π%↑ • C↓ .: AD  .: GDPR↓ & PL↓ .: u%↑ & π%↓ • Δ Gross Private Investment (IG) • IG↑ .: AD  .: GDPR↑ & PL↑ .: u%↓ & π%↑ • IG↓ .: AD  .: GDPR↓ & PL↓ .: u%↑ & π%↓

  7. Changes (Δ)in AD (cont) • Δ Government Spending (G) • G↑ .: AD  .: GDPR↑ & PL↑ .: u%↓ & π%↑ • G↓ .: AD  .: GDPR↓ & PL↓ .: u%↑ & π%↓ • Δ Net Exports (XN) • XN↑ .: AD  .: GDPR↑ & PL↑ .: u%↓ & π%↑ • XN↓ .: AD  .: GDPR↓ & PL↓ .: u%↑ & π%↓

  8. Increase in AD SRAS LRAS PL  P1  P AD1 AD  Y YF GDPR C↑, IG↑, G↑ and/or XN↑ .: AD  .: GDPR↑ & PL↑ .: u%↓ & π%↑

  9. Decrease in AD LRAS PL SRAS  P  P1 AD AD1  YF Y GDPR C↓, IG↓, G↓ and/or XN↓ .: AD  .: GDPR↓ & PL↓ .: u%↑ & π%↓

  10. Changes (Δ)in SRAS • Δ Input Prices • Input Prices↓ .: SRAS  .: GDPR↑ & PL↓ .: u%↓ & π%↓ • Input Prices↑ .: SRAS  .: GDPR↓ & PL ↑ .: u%↑ & π%↑ • Δ Productivity • Productivity↑ .: SRAS  .: GDPR↑ & PL↓ .: u%↓ & π%↓ • Productivity↓ .: SRAS  .: GDPR↓ & PL ↑ .: u%↑ & π%↑

  11. Changes (Δ)in SRAS (cont) • Δ Legal-Institutional Environment • Deregulation .: SRAS  .: GDPR↑ & PL↓ .: u%↓ & π%↓ • Regulation .: SRAS  .: GDPR↓ & PL ↑ .: u%↑ & π%↑

  12. Increase in SRAS SRAS LRAS PL SRAS1  P  P1 AD  Y YF GDPR Input Prices↓, Productivity↑, and/or Deregulation .: SRAS  .: GDPR↑ & PL↓ .: u%↓ & π%↓

  13. Decrease in SRAS SRAS1 LRAS PL SRAS  P1  P AD  Y1 YF GDPR Input Prices↑, Productivity↓, and/or Regulation/Business Taxes ↑ .: SRAS  .: GDPR↓ & PL↑ .: u%↑ & π%↑ This is known as “stagflation” and is caused by a negative supply shock. Ex—Arab Oil Embargoes of 1970’s

  14. AS / AD Summary • ΔC, ΔIG, ΔG, and/or ΔXN = Δ AD • AD  .: GDPR↑ & PL↑ .: u%↓ & π%↑ • AD  .: GDPR↓ & PL↓ .: u%↑ & π%↓ • Δ Input Prices, Δ Productivity, and/or Δ Regulation = Δ SRAS • SRAS  .: GDPR↑ & PL↓ .: u%↓ & π%↓ • SRAS  .: GDPR↓ & PL ↑ .: u%↑ & π%↑

  15. Last Minute Thoughts • Increase in G with an increase in Taxes increases AD. (Government Multiplier) • The AS/AD Model is the most important graph in AP Macroeconomics. • KNOW IT!!!

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