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AP Macroeconomics

AP Macroeconomics. The AS/AD Model. The AS/AD Model. The equilibrium of AS & AD determines current output (GDP R ) and the price level (PL ) If equilibrium of AS & AD is ON LRAS: Unemployment is 3-4% Output is where it “should” be Also at a point ON the PPC. Full Employment.

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AP Macroeconomics

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  1. AP Macroeconomics The AS/AD Model

  2. The AS/AD Model • The equilibrium of AS & AD determines current output (GDPR) and the price level (PL) • If equilibrium of AS & AD is ON LRAS: • Unemployment is 3-4% • Output is where it “should” be • Also at a point ON the PPC

  3. Full Employment • Full Employment equilibrium exists where AD intersects SRAS & LRAS at the same point. LRAS SRAS PL P AD YF GDPR

  4. Recessionary Gap • A recessionary gap exists when equilibrium occurs below full employment output. SRAS LRAS PL P AD Y YF GDPR

  5. Inflationary Gap • An inflationary gap exists when equilibrium occurs beyond full employment output. LRAS SRAS PL P AD YF Y GDPR

  6. Changes (Δ)in AD • Δ Consumption (C) • C↑ .: AD  .: GDPR↑ & PL↑ .: u%↓ & π%↑ • C↓ .: AD  .: GDPR↓ & PL↓ .: u%↑ & π%↓ • Δ Gross Private Investment (IG) • IG↑ .: AD  .: GDPR↑ & PL↑ .: u%↓ & π%↑ • IG↓ .: AD  .: GDPR↓ & PL↓ .: u%↑ & π%↓

  7. Changes (Δ)in AD (cont) • Δ Government Spending (G) • G↑ .: AD  .: GDPR↑ & PL↑ .: u%↓ & π%↑ • G↓ .: AD  .: GDPR↓ & PL↓ .: u%↑ & π%↓ • Δ Net Exports (XN) • XN↑ .: AD  .: GDPR↑ & PL↑ .: u%↓ & π%↑ • XN↓ .: AD  .: GDPR↓ & PL↓ .: u%↑ & π%↓

  8. Increase in AD SRAS LRAS PL  P1  P AD1 AD  Y YF GDPR C↑, IG↑, G↑ and/or XN↑ .: AD  .: GDPR↑ & PL↑ .: u%↓ & π%↑

  9. Decrease in AD LRAS PL SRAS  P  P1 AD AD1  YF Y GDPR C↓, IG↓, G↓ and/or XN↓ .: AD  .: GDPR↓ & PL↓ .: u%↑ & π%↓

  10. Changes (Δ)in SRAS • Δ Input Prices • Input Prices↓ .: SRAS  .: GDPR↑ & PL↓ .: u%↓ & π%↓ • Input Prices↑ .: SRAS  .: GDPR↓ & PL ↑ .: u%↑ & π%↑ • Δ Productivity • Productivity↑ .: SRAS  .: GDPR↑ & PL↓ .: u%↓ & π%↓ • Productivity↓ .: SRAS  .: GDPR↓ & PL ↑ .: u%↑ & π%↑

  11. Changes (Δ)in SRAS (cont) • Δ Legal-Institutional Environment • Deregulation .: SRAS  .: GDPR↑ & PL↓ .: u%↓ & π%↓ • Regulation .: SRAS  .: GDPR↓ & PL ↑ .: u%↑ & π%↑

  12. Increase in SRAS SRAS LRAS PL SRAS1  P  P1 AD  Y YF GDPR Input Prices↓, Productivity↑, and/or Deregulation .: SRAS  .: GDPR↑ & PL↓ .: u%↓ & π%↓

  13. Decrease in SRAS SRAS1 LRAS PL SRAS  P1  P AD  Y1 YF GDPR Input Prices↑, Productivity↓, and/or Regulation/Business Taxes ↑ .: SRAS  .: GDPR↓ & PL↑ .: u%↑ & π%↑

  14. AS / AD Summary • ΔC, ΔIG, ΔG, and/or ΔXN = Δ AD • AD  .: GDPR↑ & PL↑ .: u%↓ & π%↑ • AD  .: GDPR↓ & PL↓ .: u%↑ & π%↓ • Δ Input Prices, Δ Productivity, and/or Δ Regulation = Δ SRAS • SRAS  .: GDPR↑ & PL↓ .: u%↓ & π%↓ • SRAS  .: GDPR↓ & PL ↑ .: u%↑ & π%↑

  15. Increase in G with an increase in Taxes increases AD. (Multiplier) • The AS/AD Model is the most important graph in AP Macroeconomics. • KNOW IT!!!

  16. Assume the US economy is in a state of full employment. • Draw a correctly labeled AS/AD graph showing representing that fact. • Now suppose that private investment decreases. Show the effect of that decrease on your AS/AD graph. • Explain the impact of the decrease in private investment.

  17. Long-Run Aggregate Supply (LRAS) • scenario to illustrate the point that we will always (hopefully) come back to LRAS and why/how LRAS is independent of price level • To produce more than full employment output overtime is necessary. • Input costs (labor) will go up • When input costs are free to change, the high demand for them will start to raise input costs and lead to cost push inflation

  18. Long-Run Aggregate Supply (LRAS) • As input prices increase firms profits will fall until rise in input prices match the change in output prices. • Firm profits return to original levels and firms will be motivated to produce at FE output level

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