6. AS-AD model, finance and money Flashcards
(50 cards)
what is the employment metrics
Unemployment Rate
Employment Rate
Economic Activity Rate
what are the economic Policies to Reduce Unemployment
-Monetary Policy: Adjusting interest rates and money supply to influence economic activity (e.g., lowering interest rates to boost investment and job creation).
-Fiscal Policy: Government spending and taxation policies to stimulate demand (e.g., increasing infrastructure spending to create jobs).
what is the AS-AD model
Aggregate Supply - Aggregate Demand (AS-AD) model is a key macroeconomic tool used to analyze short-term economic fluctuations, including inflation, recession, and economic growth.
-> models the relationship between real GDP and the price level
price level def
(average price of goods and services).
what are the key functions of the AS-AD model
-Explains Inflation & Business Cycles: Helps analyze how price levels change due to supply and demand shocks.
-Examines Short-Term Macroeconomic Issues: Helps policymakers understand the effects of fiscal and monetary policy.
-Represents the Economy as a Whole: The model is based on an imaginary market that includes all final goods and services produced in the economy.
what are the 3 key components of the AS-AD model
*Aggregate Demand (AD) Curve: the total demand for all goods and services in an economy at different price levels (including I, C, G and net exports)
Slopes downward because:
Wealth effect: Higher prices reduce purchasing power.
Interest rate effect: Higher prices lead to higher interest rates, reducing investment and consumption.
Net export effect: Higher domestic prices make exports less competitive.
*Aggregate Supply (AS) Curve: total quantity of goods and services that firms in an economy are willing to produce at different price levels.
Short-Run Aggregate Supply (SRAS): Slopes upward because firms increase output when prices rise
-> due to sticky wages: wages take time to adapt to changes so with rise of price of goods, firms make pofit and with that they produce more goods
-> and due to sticky prices: some firms cannot change their price easily (or scared to loose clients) so they produce more.
Long-Run Aggregate Supply (LRAS): in the long run, the economy produces at its full capacity, regardless of price levels SO LRAS curve is a vertical line at potential GDP
*Macroeconomic Equilibrium
The intersection of AD and AS determines the economy’s output and price level.
Short-run equilibrium: Real GDP can be above or below potential GDP.
Long-run equilibrium: The economy adjusts back to its potential GDP over time.
on what depend the aggregate supply (in the AS-AD model)
level of real GDP (Y) depends on three key factors:
-Labor (L): The number of workers available and their productivity.
-Capital (K): Machinery, tools, infrastructure, and other physical assets.
-Technology (T): The efficiency and innovation in production processes.
link btwn aggregate supply and real GDP
Real GDP represents the total value of goods and services produced in an economy, adjusted for inflation. Aggregate Supply (AS) describes the relationship between the economy’s total output and the price level, showing how firms respond to changing economic conditions.
effects of labour, capital and technology on real GDP in short and long run
*short: Capital and Technology are fixed bcs they take time to change, but Laborli can vary, meaning changes in employment levels affect short-run output (If more workers are hired, real GDP increases. If businesses lay off workers, real GDP decreases).
*long: Over time, capital and technology can change, allowing the economy to expand.
Real GDP reaches its full potential (potential GDP) because wages and prices adjust fully.
-> real GDP is determined by the economy’s productive capacity (L, K, and T), not by price levels.
what are the 3 economic states of the labour market
*Below full employment: Unused resources, leading to a recessionary gap (real GDP < potential GDP).
*At full employment: The economy is operating at potential GDP (Y = potential GDP).
*Above full employment: High demand pushes real GDP above its long-term sustainable level, causing inflationary pressures.
Short-Run vs. Long-Run Aggregate Supply
- Short-Run Aggregate Supply (SAS) Curve:
key feature: Prices of resources (wages, raw materials) are fixed, meaning firms can temporarily produce more when prices rise
-economy can produce more or less than its potential GDP.
-The price level changes, but wages and input costs (resource prices) remain fixed.
-> real GDP increases with rising price levels:
-Firms see higher prices as an incentive to produce more (since costs haven’t risen yet), so profits increase - Long-Run Aggregate Supply (LAS) Curve:
-all prices, including wages, adjust proportionally.
-Real GDP always equals potential GDP because wages and resource prices adjust fully, canceling out any impact of price level changes.
how is the LAS curve in the labour market?
Long-run aggregate supply curve:
vertical because potential GDP does not depend on price levels—it is determined by labor, capital, and technology.
what are the main eco theories on aggregate supply
*Classical economists: wages and prices adjust quickly, bringing the economy back to full employment.
Keynesian economists: wages are “sticky” (slow to adjust), leading to prolonged unemployment and the need for government intervention.
Interpreting Point C (Intersection Between SAS and LAS Curves)
Point C represents equilibrium at potential GDP.
At this point, the economy is producing at full employment.
The intersection of SAS and LAS here implies that money wages adjust to changes in the price level in the long run
the downward slope of the aggreagate demand curve is explained by three key effects:
- Wealth Effect: As the price level increases, the purchasing power falls so individuals save more and spend less so lower consumption and thus lower aggregate demand.
- Intertemporal Substitution Effect (interest rate effect)
-When the price level rises, the real value of money falls, leading to higher interest rates.
-> makes borrowing more expensive, and people tend to reduce their current spending (especially on big-ticket items like houses and cars) in favor of saving more so lower borrowing and spending, decreasing aggregate demand. - International Substitution Effect (net export effect)
-domestic prices rise, goods and services produced in the domestic economy become more expensive relative to goods and services from other countries so foreign buyers purchase fewer domestic goods (exports fall), and domestic consumers buy more foreign goods (imports rise) -> lowers real GDP and aggregate demand.
def wealth, disposable income, transfert payment, interest rate, money supply, currency
*disposable income: income after taxes
*transfert payment: payments made by the government to individuals, typically without any corresponding exchange of goods or services. Examples include unemployment benefits, social security payments, and welfare.
*wealth: the total value of assets owned by individuals or households, including things like houses, savings, and investments.
-> wealth effect: When wealth rises consumers are likely to spend more, thus increasing aggregate demand.
*interest rate: the cost of borrowing money (=/savings)
*money supply: the total amount of money available in the economy. It includes currency, bank deposits, and other liquid assets.
*currency: the official money used in an economy, such as dollars, euros, or yen
what are the factors that affect aggregate demands (AD)
*Expectations About Future Income and Inflation:
*Fiscal Policy
*Monetary Policy
*The World Economy
explain how fiscal policy affects AD
-Tax and Transfer Payments: Lower taxes or higher transfer payments increase disposable income, boosting consumption
-Increased government spending directly raises aggregate demand by increasing demand for goods and services in the economy since government spending (G) is one of the direct components of AD (AD=C+I+G+(X−M)).
ex: If the government spends more on infrastructure (e.g., roads, schools, hospitals), it directly increases demand for materials, labor, and construction services.
explain how expectations about future income and inflation affects AD
-If consumers expect higher income or lower inflation in the future, they are likely to increase their current consumption (son more aggregate demand).
-If businesses expect higher future profits, they are more likely to increase investment (I) today, which raises aggregate demand.
explain how monetary policy affects AD
-Interest Rates: Lower interest rates encourage borrowing and spending, which increases aggregate demand.
-Money Supply: An increase in the money supply lowers interest rates and stimulates spending, increasing aggregate demand.
explain how the world economy affects AD
-Foreign Exchange Rate: A weaker domestic currency (a lower exchange rate) makes exports cheaper and imports more expensive. This increases net exports, raising aggregate demand.
-Foreign Income: Higher income levels in other countries lead to greater demand for domestic exports, increasing aggregate demand.
what is AS-AD short-run equilibrium, what happends if price level is above/ below equilibrium?
-> occurs where the Aggregate Demand (AD) curve intersects the Short-Run Aggregate Supply (SAS) curve, determining real GDP and price level.
*above: the quantity of real GDP supplied exceeds the quantity demanded (surplus of goods and services).
-> Firms cut prices to sell excess inventory, leading to a lower price level and moving the economy toward equilibrium.
*below: the quantity of real GDP demanded exceeds the quantity supplied (shortage of goods and services).
-> Firms respond by raising prices, leading to higher inflation until the economy reaches equilibrium.
AS-AD Long-Run Equilibrium
What happens if real GDP is below or above potential GDP?
occurs where the AD curve, the SAS curve, and the Long-Run Aggregate Supply (LAS) curve intersect: GDP equals potential GDP, and the economy is fully adjusted.
*real GDP below potential GDP (recessionary gap):
Unemployment is high, and wages eventually fall as workers accept lower pay.
Lower wages reduce production costs, shifting the SAS curve right, restoring full employment.
*above potential GDP (inflationary gap):
The economy overheats, causing wages and input prices to rise.
Higher costs shift the SAS curve left, pushing output back to potential GDP.
Over the long run, money wages adjust, ensuring that real GDP returns to potential GDP
AS-AD Model: Economic Growth and Inflation
*Economic growth shifts the LAS curve right over time due to increases in labor, capital, and technology. This expands the economy’s productive capacity.
*Inflation occurs when AD increases at a faster pace than LAS (demand for goods and services grows faster than the economy’s ability to produce them). This results in higher price levels over time, leading to inflationary pressures.
