Chapter 29: The AD-AS model
What AD-AS Model show
AD-AS model shows the level of price and output through aggregate demand and aggregate supply relationships.
The three reasons that explain why the AD curve slopes downwards
The effects of Pigou, Keynes rate of interest and the exchange rate effect of Mundell-Fleming are the three reasons that explain the downward sloping of AD (Rao, no page).
What causes a movement along the AD curve
Movement in the aggregate demand curve is often caused by prices. The amount of supply of real money declines when the level of price rises and eventually, interest rates rise. High rates of interest reduce both savings and investment thus lowering income within a short span of time (Rao, no page).
Factors that cause the AD curve to shift
Spending on both goods and services by consumers, investment spending on capital goods of a business, exports, imports and spending by the government on public services and goods in addition to a price change, are held strongly responsible for the shift of the AD curve.
Distinguishing between the government spending multiplier and the tax multiplier
Government expenditure multiplier entails an increase that is autonomous in spending by the government while it generates multiple income expansion. In other words, it entails the ratio of income change to the change of spending by the government. Tax multiplier, on the other hand, shows or represents the multiple by which Gross Domestic product decrease or increases depending on either tax increase or decrease (Lumen, no page).
How changes in government spending can have a multiplier effect on AD
The multiplier of government spending shows how AD’s change results from spending. Increment in government spending leads to increment in both consumption and income. Increasing government situations may lead to a situation of increased tax in goods and services by the government which decreases income and consumption of goods and services. This negatively affects the aggregate demand of goods and services causing a negative shift in its curve.
Explain how changes in taxes can have a multiplier effect on AD
Tax reduction to goods and services leads to increased demand. The extend in which aggregate demand increase is depended on both the tax and spending multipliers. Being an aggregate demand’s magnification effect, tax multiplier causes a change in tax on AD. A decrease in tax leads to increased income and the consumption of goods and services.
The difference between short and long run in the economy
The short-run holds the idea that the behavior of the economy is different and is dependent on the time haven to respond to stimuli. It fails to refer to the duration of time that is specific but rather unique to the variables of firms, economy and industry under study. Firms, therefore, face both fixed and variable costs indicating that wages, prices and output lack the freedom to reach a balance of opposing forces. In long-run, the general level of prices, contractual rate of wages and expectations adjust fully to the economic state. This contrasts the short-run in which variables cannot adjust fully to the economic state.
Why the long-run aggregate supply (LRAS) curve vertical
The Long Run Aggregate Supply curve is vertical for the reason that the potential out that can be produced by the economy is greatly related to the level of prices particularly, in the long-run. The curve is as well vertical at the output’s full level of employment because it remains the amount that the economy can produce upon full adjustment of prices (Khan Academy, no page).
What does the LRAS curve show? Why is an economy’s long-run output equal to its potential RGDP?
The Long Run Aggregate Supply shows the relationship that exists between the level of prices and the Gross Domestic Product (real) that would get supplied if the flexibility of all prices was full. Along with the Long Run Aggregate, the supply price is subject to change while output remains fixed.
In the economy long-run output equal to its RGDP potential this also equals aggregate expenditure. This is due to the reason that the level of the price must be at a point where both the AS and AD meet.
A Graph Showing The Meeting Point Of AD And AS Curves And The Level Of Long-Run Price
The unemployment rate when the economy produces its long-run output
The rate of unemployment equals the unemployment rate that is natural when the economy produces its long-run output (Khan Academy, no page).
The cause of shifts of LRAS curve(s)
A shift of the LRAS curve may be caused by the changes in the economy’s productivity usually through an increase in scarce resources’ quantity or resources’ quality improvement achievable through training and education.
How the LRAS curve explain long-run economic growth and inflation
The actual growth of the economy is shown by the change of the output of equilibrium in the LRAS curve. The shift shows changes in growth potentials such as full employment changes. At the point where AD and AS intersect to set equilibrium, actual growth is shown. The growth of the economy is a result of decreased inflation. An increase in inflation will cause prices of products to be high due to increased interest rates and unemployment rate increase leading to the fall of the economy (Rao, no page).
Defining short-run aggregate-supply (SRAS): What the SRAS curve show
Khan Academy (no page) defined Short Run Aggregated Supply as a model presented graphically to show a relationship that is positive, between the aggregate level of the price(s) and the supplied amount of aggregate output in the economy.
The correlation between the level of price and output is often shown by the SRAS curve. As the level of prices increases and one moves along the curve, the Real Gross Domestic Product produced increases. Finally, the SRAS curve must show that the price level relationship with aggregate output always positive (Khan Academy, no page).
The explanation of sticky wage (or any input price) theory explain the upward slope of the SRAS curve
The entrance of stickiness in market causes a change to be favored in a direction more than the other. Consequently, change trends in the favored direction. Since wages are stick-down, their movement trend in upward direction than its downward. This eventually leads to a trend that is average to the wage’s upward movement.
Factor that causes a movement along the SRAS curve
Price is the major contributor of movement along SRAS curve. Increase in the level of prices causes a decline in the supply of real money which further forces the rising rates of interest. High rates of interest reduce both savings and investment and eventually income is lowered for a short period. Decrease in price level increases money supply as the rates of interest go low, encouraging savings and investment. Other factors include wages and prices of raw materials.
Factors that cause the SRAS curve to shift
Price levels, wages, taxes and the price of law materials are the causal factors to the shift in SRAS curve.
Defining macroeconomic equilibrium: Macroeconomic equilibrium characteristics? Illustrate with a graph.
LRME occurs when there is equity between the actual GDP and GDP potential on the curve of LRAS. An inflation gap tends to occur when RGDP exceeds the potential GDP. At the event when RGDP is lower than GDP potential, a gap of recession gets created. LRME therefore, is a point characterized by a settled economy. Producers at this point, have their output potential of economy fully attained.
Understanding output gap: Identifying the two types of output gaps
Output gap entail an economic tool that measures the difference between economy’s actual output and the potential economic output. When the output gap is positive, growth is said to be above both inflation and the rate of trend. Negative output gap shows that economy is down-falling with unemployment being first noted.
Economy’s self -correcting mechanism
The self-correction mechanism of economy closes recessionary gaps that are characterized with low wages while increasing the curve of SRAS.