The AS/AD Model (2/22/17)

• The equilibrium of AS & AD determines the current output (GDP_R) and the price level (PL)

Full employment 

• Full employment equilibrium exists where AD intersects SRAS & LRAS at the same point. 

Inflationary Gap

Output is high and unemployment is less than NRU

Note: An inflationary gap caused by a rightward shift in AD is also known as 'demand pull inflation'

Recessionary Gap 

Output is low and unemployment is more than NRU.

Lower GDP = More Unemployment & Lower Income!

Changes (∆) in AD
↑↓→←∆

• ∆ Consumption (C)

- C↑ .: AD→ .: GDP_R↑ &PL↑ .: u%↓ & π%↑

- C↓ .: AD← .: GDP_R ↓ & PL↓ .: u%↑ & π%↓

• ∆ Gross Private Investment (I_G)

- I_G↑ .: AD→ .: GDP_R↑ & PL↑ .: u%↓ & π%↑

- I_G↓ .: AD← .: GDP_R ↓ & PL↓ .: u%↑ & π%↓

• ∆ Government Spending (G)

- G↑ .: AD→ .: GDP_R↑ & PL↑ .: u%↓ & π%↑

- G↓ .: AD← .: GDP_R ↓ & PL↓ .: u%↑ & π%↓

• ∆ Net Exports (X_N)

- X_N↑ .: AD→ .: GDP_R↑ & PL↑ .: u%↓ & π%↑

- X_N↓ .: AD← .: GDP_R ↓ & PL↓ .: u%↑ & π%↓

Decrease in AD

Increase in AD

Change (∆) in SRAS

• ∆ Input Prices

- Input Prices↓  .: SRAS → .: GDP_R↑ & PL↓ .: u%↓ & π%↓

- Input Prices↑  .: SRAS ← .: GDP_R ↓ & PL↑ .: u%↑ & π%↑

• ∆ Productivity

- Productivity↑  .: SRAS → .: GDP_R↑ & PL↓ .: u%↓ & π%↓

- Productivity↓  .: SRAS ← .: GDP_R ↓ & PL↑ .: u%↑ & π%↑

• ∆ Legal-Institutional Environment

- Deregulation .: SRAS → .: GDP_R↑ & PL↓ .: u%↓ & π%↓

- Regulation .: SRAS ← .: GDP_R ↓ & PL↑ .: u%↑ & π%↑

Increase in SRAS

Decrease in SRAS