Putting All Markets Together: The ASAD Model

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Putting All Markets TogetherThe AS-AD Model

• Slides based on Blanchard (2002) 3rd ed, and
  slides prepared for Prentice Hall Business
  Publishing by Fernando and Yvonn Quijano.
• Data made available by Oxford Economic
  Forecasting Ltd.

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Aggregate Supply

• The aggregate supply relation captures the
  effects of output on the price level. It is
  derived from the behavior of wages and prices.
• Recall the equations for wage and price
  determination from Chapter 6

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Deriving the AggregateSupply Relation

• Step 1 Eliminate the nominal wage from

and
, then
In words, the price level depends on the expected
price level and the unemployment rate. We assume
that ? and z are constant.
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Deriving the AggregateSupply Relation

• Step 2 Express the unemployment rate in terms
  of output

Therefore, for a given labor force, the higher is
output, the lower is the unemployment rate.
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Deriving the AggregateSupply Relation

• Step 3 Replace the unemployment rate in the
  equation obtained in step one

In words, the price level depends on the expected
price level, Pe, and the level of output, Y (and
also ?, z, and L, but we take those as constant
here).
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Properties of the AS Relation

• The AS relation has two important
  properties
• An increase in output leads to an increase in the
  price level. This is the result of four steps

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Properties of the AS Relation

• An increase in the expected price level leads,
  one for one, to an increase in the actual price
  level. This effect works through wages

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The Aggregate Supply Curve

• Given the expected price level, an increase
  in output leads to an increase in the price
  level. If output is equal to the natural level
  of output, the price level is equal to the
  expected price level.

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Properties of the AS curve

• The AS curve is upward sloping. As explained
  earlier, an increase in output leads to an
  increase in the price level.
• The AS curve goes through point A, where Y Yn
  and P Pe. This property has two implications
• When Y gt Yn, P gt Pe.
• When Y lt Yn, P lt Pe.
• An increase in Pe shifts the AS curve up, and a
  decrease in Pe shifts the AS curve down.

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Expected Prices and Aggregate Supply

• An increase in the expected price level
  shifts the aggregate supply curve up.

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Aggregate Demand

• The aggregate demand relation captures the effect
  of the price level on output. It is derived from
  the equilibrium conditions in the goods and
  financial markets.
• Recall the equilibrium conditions for the goods
  and financial markets described in chapter 5

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The Derivation of the Aggregate Demand Curve
An increase in the price level leads to a
decrease in output.
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Aggregate Demand
Changes in monetary or fiscal policyor more
generally in any variable, other than the price
level, that shift the IS or the LM curvesshift
the aggregate demand curve.