Download AD/AS Model and Inflation

AD/AS Model and Inflation
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[export
receipts (X) – Import payments (M)]
• AD = C + I + G + (X-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
What might cause a change in AD???
AD
C
I
G
X
M
income
interest
rates
Govt
spending
decisions
exchange
rate
exchange
rate
overseas
demand
tastes
preferences
overseas
trade
barriers e.g.
tariffs
NZ trade
barriers e.g.
tariffs
direct tax/
income tax
business
confidence
consumer
confidence
interest
rates
inflationary
expectations/ future prices
tastes/
preferences
Shifts of the AD curve
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 imported raw materials)
– Productivity ( influenced by investment and technology)
Are all held constant
If any of these three factors change then there will be a
shift of the AS curve
What might cause a change in AS???
AS
 nominal wages
Imported
raw materials
cost
exchange
rates
overseas
price
productivity
technology
skilled labour
leaving NZ
Indirect Tax
GST tax
excise tax
Technology
Shifts of the AS curve
Equilibrium
Occurs where AD=AS
This level also indicates
• The price level Ple (Inflation
rate)
• the level of employment ,
output and Real GDP (Ye)
Equilibrium AD/AS
Price
Level
YF shows full employment.
YF - Ye shows the level
unemployment level that exists
PLe
Ye
YF
Real GDP
(Output and
employment)
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
.
Using the AD/AS model to illustrate
Inflation
• Inflation = any increase in the general price
level in the economy
• There are two changes on the AD/AS model
that will result in inflation
1. Increase in AD
2. Decrease in AS
Increase in AD (Demand Pull Inflation)
• Any factor that causes a rise in AD, will cause a rise
in the general level of prices, this is called demand
pull inflation
PL2
Inflation
occurring
PL1
Decrease in AS (Cost Push Inflation)
• Any factor that causes a fall in AS, will cause a rise
in the general level of prices, this is called cost
push inflation
PL2
Inflation
occurring
PL1
• Demand Pull Inflation
• Workbook 27-29
• Cost Push Inflation
• Workbook 32-34
• Task Sheet 8 and 9