*AD/AS Model

*AD/AS Model

Aggregate = Total

Aggregate Demand = Total demand in the economy

Aggregate Supply = Total supply in the economy

*Aggregate Demand Curve

*Shows the total demand in an economy at each price level

*Price Level = general level of prices (Measures inflation)

*Aggregate demand is demand from each of the sectors of the economy

*Aggregate Demand

*AD = consumption spending (c) + Investment spending (I) + government spending (g) + net exports[exports (x) – Imports (m)]

*If any of the components increases, then AD will increase and cause the AD curve to shift to the right

*If any of these components decreases, the AD will decrease and cause the AD curve to shift to the left

*Shifts of the AD curve

*Change in any variable in the AD equation (AD=C+ I+ G+ (X-M)) will move the AD curve itself.

Shift to the right

C G X

Shift to the Left

C G X

*Aggregate Supply

*The aggregate supply curve shows the total output in an economy at each price level

*The aggregate supply curve is drawn assuming that

*Nominal wages (Cost of production)

*Import prices (cost of raw materials)

*Productivity ( influenced by investment and technology)

Are all held constant

*Shifts of the AS curve

Shift to the right:Wages

Imported raw

materials

Productivity

Shift to the left

Wages

Imported raw materials

Productivity

*Equilibrium

Ye

PLe

Occurs where AD=AS and the price level PLe.

This level also indicates the level of employment (Ye)

Equilibrium represents where the economy will tend to move towards. Once we are at this equilibrium the economy will stay here unless AD or AS moves

Equilibrium AD/AS

*Yr 13 Only Equilibrium

YfYe

PLe

Full employment (economic potential)

Equilibrium AD/AS

Changes to Equilibrium A change in either aggregate demand or aggregate supply results in a change in the equilibrium price level and a change in the level of national income, output and employment.

Y

Price Level

An increase in AS•A decrease in the price level

•An increase in real income, output and employment

AS’

PL

PL’

Ye Ye’

AS’’

Ye’’

PL ‘’

A decrease in AS

An increase in the price level

A decrease in real income, output and employment levels

Changes in AD and AS

What will happen if there is an increase in AD?

Increase in price level Increase in real income, output and employment What will happen if there is a decrease in AD? A decrease in price level A decrease in real income, output and

employment.