III. AD & AS Equilibrium

Shifters of Aggregate Demand Change in C onsumer Spending Change in I nvestment Spending Change in G overnment Spending Net E X port Spending AD = C + I + G + X Shifters of Aggregate Supply AS = I + R + A + P Change in R esource Prices Change in A ctions of the Government Change in P roductivity (Investment) 2 Change in I nflationary Expectations

B A D A D B A A C A major increase in productivity. A Answer and identify shifter: C.I.G.X or R.A.P 3

A. Inflationary and Recessionary Gaps 4

Price Level 5 AD AS 1.Inflationary Gap Example: Assume the government increases spending. What happens to PL and Output? GDP R LRAS QYQY AD 1 PL e PL 1 Q1Q1 PL and Q will Increase

Price Level 6 AS GDP R LRAS QYQY AD 1 PL 1 Q1Q1 Output is high and unemployment is less than NRU Actual GDP above potential GDP

Price Level 7 AD AS GDP R QYQY PL e PL 1 Q1Q1 LRAS AS 1 Stagflation Stagnate Economy + Inflation 2. Recessionary Gap Example: Assume the price of oil increases drastically. What happens to PL and Output?

Price Level 8 AD GDP R QYQY PL 1 Q1Q1 LRAS AS 1 Output low and unemployment is more than NRU Actual GDP below potential GDP

AD and AS Practice Worksheet 9

How does this cartoon relate to Aggregate Demand? 10

Price Level GDP R AS AD=C+I+G+X P2P2 P1P1 AD 2 Q f (Y*or FE) LRAS Q2Q2 Draw AD and AS at full employment Output IncreasesPL Increases 11

B. Changes from Short Run to Long Run

Price Level 13 AD AS Shifts in AD or AS change the price level and output in the short run GDP R QYQY PL e LRAS

Price Level 14 AD AS Example: Assume consumers increase spending. What happens to PL and Output? GDP R LRAS QYQY AD 1 PL e PL 1 Q1Q1

Price Level 15 AD AS Now, what will happen in the LONG RUN? GDP R QYQY AD 1 PL e PL 1 Q1Q1 LRAS Inflation means workers seek higher wages and production costs increase AS 1 PL 2 Back to full employment with higher price level

Price Level 16 AD AS Example: Consumer expectations fall and consumer spending plummets. What happens to PL and Output in the Short Run and Long Run? GDP R LRAS QYQY AD AD 1 PL 1 Q1Q1 AS 1 PL 2 PL e AS increases as workers accept lower wages and production costs fall