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Download The Aggregate Demand -- Aggregate Supply Model
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The Aggregate Demand -Aggregate Supply Model Fundamental inflexibility assumptions: W -- inflexible (short-run) -- flexible (long-run) P -- flexible i -- flexible. Overriding theme -- policies affect the price level as well as real GDP. Properties of Aggregate Demand (AD) Curve Downward sloping. Expansionary shifts in the IS or LM curves shift the AD curve rightward (fiscal or monetary policy). Contractionary shifts in the IS or LM curves shift the AD curve leftward (fiscal or monetary policy). Properties of the Short-Run Aggregate Supply Curve Upward sloping (W inflexible) Variables that enhance production shift the SAS curve rightward. Variables that hinder production shift the SAS curve leftward. Shift variables -- SAS Curve Nominal Wage Rate (W) Capital Stock Labor Productivity Price of Energy Properties of the Long-Run Aggregate Supply Curve Vertical at Y = YN. Variables that enhance production shift the LAS curve rightward. Variables that hinder production shift the LAS curve leftward. Shift Variables -- LAS Curve (Variables That Change YN) Capital Stock Labor Productivity (output)/(labor hours) Price of Energy Labor Force Household Attitudes Toward Work Transfer Payments Lengthening the Short-Run (Demand Policy) Encourage long-term, non-indexed nominal wage contracts. Keep inflation expectations down. -- seek gradual policy changes (“soft landing”) -- verbal reassurances on inflation Watch closely for unusual increases in nominal wage rates. Rational Expectations Rational Expectations -- People form expectations using all available information in the most efficient way. Truly the “best guess.” Errors between actual expected variables are totally unpredictable, and independent from the set of available information. Rational Expectations, Continued Corresponds to fundamental assumption on human behavior, rationality (according to the economic definition). Application -- efficient markets (Finance), and predicting movements in stock prices. Supply Shocks Supply Shock – large increase in the price of energy (US: 1973, 1978, 1990, 2007). -- shifts SAS curve leftward P*, Y*. Possible Policy Responses to Supply Shocks Extinguishing Response (1973) – attempts to extinguish the increased inflation practice contractionary demand policy. Validating Response (1978) – attempts to protect output, keep the economy out of recession practice expansionary demand policy. Do nothing (2007) – best solution Positive Supply Shifts Shifts both SAS curve and LAS curve rightward P*, Y*, YN -- decrease price of energy -- increase labor productivity -- increase the capital stock. The Record of US Labor Productivity Steadily increasing over time Tripled since 1960 Increased after Great Recession, has leveled off (good sign for hiring?)
