ADAS Flashcards
(25 cards)
Facts about economic fluctuations
- irregular and difficult to predict
- most macroeconomic quantities fluctuate simultaneously
- as output falls, unemployment rises
What is the main difference about assumptions in the short run versus long run
- classical dichotomy does not hold as real and nominal variables are intertwined
- money neutrality also is not appropriate
What is the AD-AS model
- model of aggregate demand and aggregate supply
- focuses on the relationship between prices and real GDP
What does the aggregate demand curve show
- the quantity of goods and services wanted at each price level
- downward sloping
What does the aggregate supply curve show
- the quantity of goods and services that firms are willing to produce and sell at each price level
- upward sloping (in the short run)
What is on the axes for ADAS
- y axis is price level
- x axis is output
- equilibrium is the point where these graphs intersect
Which three effects explain why the AD curve slopes downwards
- wealth effect (C)
- interest rate effect (I)
- exchange rate effect (NX)
G is fixed by policy
What is the wealth effect (C)
- a decrease in price level results in an increase of value of money
- consumers feel wealthier and spend more so aggregate demand increases
What is the interest rate effect (I)
- a decrease in price level reduces interest rates as the increase in real money supply results in an increased demand for investments
- so aggregate demand increases
What is the exchange rate effect (NX)
- decrease in UK price level depreciates the GBP which stimulates exports and suppresses imports
- thus increasing net exports and also aggregate demand
Overall, what does a decrease in price level cause on the AD curve
A movement down the curve
Why might the AD curve shift?
A change in any non price factor (C, I, G, NX)
What is the difference between LRAS curve and SRAS curve
- LRAS curve is vertical at the rate of natural output where unemployment is at its natural rate and the factors of production are fully utilised
- SRAS is upwards sloping
Why is the LRAS curve vertical
In the long run GDP is determined by: capital, labour, technology and natural resources so the long run output is the same regardless of price level
What causes a shift in LRAS
Changes in the factors of GDP (capital, natural resources, technology and labour)
What happens to AD and LRAS long term
- continual shift of LRAS to the right due to technological advancements
- AD curve shifts to the right due to monetary policy
- this results in a continued growth in output and continuing inflation
How does AS act in the short run
An increase in overall level of prices raises the quantity of goods supplied
(upward sloping)
Three theories explaining why AS slopes upwards in short term
- sticky wage theory
- sticky price theory
- misperceptions theory
What is each theory for SRAS sloping upwards based on
A market imperfection focusing on the difference between expected price (EP) and actual price (AP)
What happens when price level rises above the expected level
Output increases
the reverse is true for when it falls below
Explain sticky wages theory
- nominal wages are slow to adjust to changing economic conditions as contracts are fixed
- since nominal wages are based on expected prices, wages do not respond immediately
- if AP<EP, real wages are higher and marginal costs are greater so cut production and hire fewer workers (output falls)
- if AP>EP, costs are lower and firms increase production
Explain sticky prices theory
- the prices of most goods and services are fixed or slow to adjust short term (menu costs)
- this implies upwards sloping SRAS as prices are marginal revenue
- if AP<EP then actual revenue is lower than expected and firms cut production
- if AP>EP firms increase output
Explain misperceptions theory
- firms misinterpret a rise in general price level as a rise in their products price
- firms respond by producing more so output increases
- vice versa for falls in prices
What is a general short run supply equation
Ys=Yn + a(AP-EP)
Ys = quantity supplied
Yn = natural rate of output (LRAS)
a = coefficient determining how much output responds to unexpected change
