AD/AS Model

1
AD/AS Model

• Diedra Flora
• AP Macroeconomics

2
Short-Run Equilibrium

• The equilibrium of SRAS AD determines current
  output (GDPR) and the price level (PL)

SRAS
PL

P
AD
GDPR
YF
3
Full Employment

• Full Employment equilibrium exists where AD
  intersects SRAS LRAS at the same point.

SRAS
LRAS
PL

P
AD
GDPR
YF
4
Shifts of AD Short-Run Effects

• An event that shifts the AD curve is known as a
  demand shock.
• The economy can experience positive or negative
  demand shocks.
• Causes of demand shock are change in
  expectations, wealth, the stock of physical
  capital, or the use of fiscal or monetary policy.

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Negative Demand Shock

• A negative demand shock shifts the AD curve to
  the left, lowering PL and Real GDP.

SRAS
PL
P
P1
AD
AD1
GDPR
Y
Y1
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Positive Demand Shock

• A positive demand shock shifts the AD curve to
  the right, raising PL and Real GDP.

SRAS
PL
P1
P
AD1
AD
GDPR
Y1
Y
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Shifts of AS Short-Run Effects

• An event that shifts the AS curve is known as a
  supply shock.
• The economy can experience positive and negative
  supply shocks.
• Causes of supply shocks are changes in commodity
  (or resource) prices, nominal wages, or
  productivity

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Negative Supply Shock

• A negative shock shifts the SRAS curve to the
  left, raising PL and lowering Real GDP.

SRAS1
PL
SRAS
P1
P
AD
GDPR
Y1
Y
9
Stagflation

• A supply shock causes a condition known as
  stagflation, for stagnation plus inflation.
• When the economy experiences stagflation, its
  very unpleasant falling output leads to rising
  unemployment, and people feel that their
  purchasing power is squeezed by rising prices.

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Positive Supply Shock

• A positive shock shifts the SRAS curve to the
  right, lowering PL and raising Real GDP.

SRAS
PL
SRAS1
P
P1
AD
GDPR
Y1
Y
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Long-Run Equilibrium

• The economy is in long-run macroeconomic
  equilibrium when the point of short-run
  equilibrium is on the long-run aggregate supply
  curve.

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Recessionary Gap Short-Run

• A recessionary gap exists when equilibrium occurs
  below full employment output because of a
  negative demand shock.

PL
SRAS
LRAS
PL
PL1
PL2
AD
AD1
GDPR
YF
Y
Decreases in AD can cause cyclical unemployment
and recession.
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Recessionary Gap Long-Run Effects

• In the long-run the economy is self-correcting.
  Wages eventually fall in response to high
  unemployment. The lower cost of production
  causes the SRAS curve to shift to the right.

PL
SRAS
LRAS
SRAS1
PL
PL1
PL2
AD
AD1
GDPR
YF
Y1
In the long-run the economy self-corrects,
bringing unemployment back to full employment,
and Real GDP back to potential GDP.
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Inflationary Gap Short-Run

• A inflationary gap exists when equilibrium occurs
  above full employment output because of a
  positive demand shock.

PL
LRAS
SRAS1
PL1
PL
AD1
AD
GDPR
YF
Y1
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Inflationary Gap Long-Run Effects

• In the long-run, the economy is self-correcting.
  The increased demand for labor will cause wages
  to increase. This will cause the SRAS curve to
  shift to the left.

PL
SRAS2
LRAS
SRAS1
PL2
PL1
PL
AD1
AD
GDPR
YF
Y1
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Supply Shocks versus Demand Shocks

• The previous analysis of a self-correcting
  economy can apply to supply shocks as well as
  demand shocks.
• Negative supply shocks (also known as cost-push
  inflation) are particularly difficult for an
  economy.
• Seven of nine postwar recessions were the result
  of demand shocks, not supply shocks. The two
  supply shocks were the two worst as measured by
  the unemployment rate.

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Increases in AS and AD Full employment, high
economic growth, and price stability

• Increases in productivity and expanding output
  occurred between 1990 and 2000 due to a burst of
  new technology relating to computers, the
  Internet, inventory management systems,
  electronic commerce, etc. The country
  experienced full employment, high economic
  growth, AND price stability.

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AS / AD Summary

• ?C, ?IG, ?G, and/or ?XN ? AD
• AD ? . GDPR? PL? . u? p?
• AD ? . GDPR? PL? . u? p?
• ? Input Prices, ? Productivity,
• and/or ? Regulation ? SRAS
• SRAS ? . GDPR? PL? . u? p?
• SRAS ? . GDPR? PL ? . u? p?
• The AS/AD Model is the most important graph in AP
  Macroeconomics.
• KNOW IT!!!

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Another Way of Drawing the SRAS Curve
SRAS
PL

GDPR
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Different shapes of the SRASThe Horizontal SRAS

• Under what conditions would an economy have a
  horizontal SRAS curve?
• When there are a lot of unemployed resources or a
  constant price level as in a recession or
  depression.

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The Positively Sloped SRAS Curve

• Under what conditions would an economy have a
  positively sloped SRAS curve?
• In this range, resources are getting closer to
  full-employment levels, which creates upward
  pressure on prices.

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The Vertical SRAS Curve

• Under what conditions would an economy have a
  vertical SRAS curve?
• SRAS is vertical when real GDP is the full
  employment level and where any increase in demand
  will result only in an increase in prices.
• The economy is unable to produce any more goods
  and services for a sustainable period of time.