Macroeconomics

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Macroeconomics

• Lecture 2
• Introduction to the AD-AS model

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Lecture on Monday the 30th cancelled Replacement
Lecture on Friday 27th in LMH at 9am.
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Outline

• Road map and the components of the AD-AS model.
• Introduction of the AD-AS model.
• Using the AD-AS model to analyse the impact of
  the oil shocks of the 1970s and monetarism in
  the 1980s in the UK.

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DAD-SAS (r,?,Y)
Labour market (AS)
Goods market Keynesian Cross (IS)
AD-AS (r,P,Y)
Y, r and P
Y given r, e and P
IS-LM (r, Y) AD
Y and r given P e
Financial markets (LM)
Foreign exchange markets
AD (r,Y,e, NX)
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Introduction to the AD-AS model
Y Real GDP
P The price level
r Real interest rate
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Aggregate demand
Combinations of P and Y at which the market for
goods and the money market are in equilibrium.
r falls
Aggregate Demand (AD)
ESM
P
A
P0
M/P increases
I increases
B
P1
P decreases
Y increases
Y
Y0
Y1
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The AD curve does NOT slope downwards because
consumers demand less at higher prices
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Positive demand shock
Expansionary policies (increase in money supply
or government spending)
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Aggregate Supply
Combinations of P and Y at which the labour is
in equilibrium.
Long-run AS (flexible w)
Employment falls
Short-run AS (W given)
P
W/P increases
Y decreases
Fixed price AS
P decreases
Y
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Macroeconomic equilibrium
C
Expansionary policies (increase in money supply
or government spending)
B
A
Long-run equilibrium
Short-run equilibrium
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Supply shocks

• Supply (or real price) shocks increase (decrease)
  costs and prices
• oil cartel
• union aggressiveness
• technological changes

Adverse shocks shift the AS up Favourable shock
shift the AS down
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Annual change in the price of oil
The first OPEC chock
The second OPEC
Cartel breaks down
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Demand shocks

• Demand shocks increase (decrease) aggregate
  demand
• policy induced (monetary and fiscal shocks)
• structural induced (credit cards)
• animal spirit and consumer optimism

Adverse shocks shift the AD down (in) Favourable
shock shift the AD up (out)
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Money Growth in the UK, 1970-90
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2
Anti-inflationary policy
Accommodating monetary policy
Source ONS, Economic Trends
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Unemployment in the UK, 1970-90
1
2
1st oil shock accommodating monetary policy
2nd oil shock anti-inflationary policy
Source Economic Trends Annual Supplement, Labour
Market Trends
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p
The first oil shock
u
76
74
72
Accommodating demand policies
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The second oil shock
p
79
u
76
Anti inflationary monetary policies
82
72
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What is next?

• The Keynesian cross model
• The multiplier
• The IS Curve
• Contrasting the Keynesian and the Classical model