Using the AS/AD ModelEvolution of Macro TheoryUsing the AS/AD ModelEvolution of Macro TheoryAS/AD ApplicationsElias YannopoulosSeptember 28, 2012Elias Yannopoulos AS/AD ApplicationsUsing the AS/AD ModelEvolution of Macro TheoryAS/AD MethodologyA couple pointsY* = Full employment output, output where u = u*Real vs Nominal economic changesStep to evaluate the AS/AD model1: Set up the model in equilibrium2: Determine which curve(s) to shift3: Determine the direction of the shift(s)4: Determine the new SR equilibrium5: Determine the new LR equilibriumElias Yannopoulos AS/AD ApplicationsUsing the AS/AD ModelEvolution of Macro TheoryAS/AD ExamplesEx: SRAS shift inEx: SRAS shift outEx: AD ShiftsRecessionary Gap - the amount by which equilibrium outputis below potential outputInflationary Gap - the amount that aggregate expendituresare above potential outputFeedback - a concept where movements of the SRAS can leadto further movements in ADEx: graphElias Yannopoulos AS/AD ApplicationsUsing the AS/AD ModelEvolution of Macro TheoryAS/AD and Classical economicsThe fundamental assumption in classical economics is that allprices adjustThere are no sticky pricesThis assumption leads to 3 main conclusionsNo extended unemploymentNo significant contractionsAn inherently stable economyFocus on supply - LRAS determines YAll sunshine and rainbowsEx: graphElias Yannopoulos AS/AD ApplicationsUsing the AS/AD ModelEvolution of Macro TheoryKeynesian EconomicsThe key assumption for Keynes is that some prices areinflexible, especially downwardMoney illusion and contractsSince input prices do not adjust then output must adjustThis leads to output below Y*An economy that is inherently unstableFocus on demand - AD determines YGovernment intervention is necessary to stabilize the economyElias Yannopoulos AS/AD ApplicationsUsing the AS/AD ModelEvolution of Macro TheoryClassical vs Keynesian SummaryClassical KeynesianKey Time Period Long Run Short RunPrice Flexibility Prices flexible Prices stickySavings Crucial to growth A drain on demandKey Side of Market Supply DemandMarket Tendency Stability InstabilityEmployment level Stable CyclicalGovernment Intervention Not necessary EssentialElias Yannopoulos AS/AD
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