113-1The IS-LM/AD-AS Model:A General Framework for Macroeconomic Analysis,Part 213-2Agenda• Aggregate Demand and Aggregate Supply13-6Aggregate Demand and Aggregate Supply •The AD-AS model is derived from the IS-LMmodel. ¾ The two models are equivalent.¾ Depending on the particular issue, one model may prove more useful than the other model.•The IS-LM model relates the real interest rate to output.•The AD-AS model relates the price level to output.13-7The AD Curve• The aggregate demand curve:¾ The AD curve shows the relationship between the quantity of goods demanded and the price level when the goods market andthe asset market are in equilibrium.•So the AD curve represents the price level and output level at which the IS and LM curves intersect.213-8Derivation of the AD CurverYYP13-9The AD CurveYP13-10The AD Curve• The aggregate demand curve:¾ The AD curve is unlike other demand curves, which relate the quantity demanded of a good to its relative price.¾ The AD curve relates the total quantity of goods demanded to the generalprice level, not a relativeprice.13-11The AD Curve• The aggregate demand curve:¾ The AD curve slopes downward because a higher price level is associated with lower real money supply, shifting the LM curve up, raising the real interest rate, and decreasing output demanded.313-12The AD Curve• Factors that shift the AD curve:¾ Both the IS and AD curves shift to the right with:• Increases in expected future output, • Increases in wealth, • Increases in government purchases,13-13The AD Curve• Factors that shift the AD curve:¾ Both the IS and AD curves shift to the right with:• Increases in the expected MPKf,• Decreases in taxes, – Assuming Ricardian equivalence does not hold, or • Decreases in the effective tax rate on capital.13-14An increase in government purchasesrYYP13-15The AD Curve• Factors that shift the AD curve:¾ Both the LM and AD curves shift to the right with: • Increases in the nominal money supply, • Increases in expected inflation, • Decreases in the real demand for money, and/or • Decreases in the nominal interest rate on money.413-16An increase in the money supplyrYYP13-17The AS Curve• The aggregate supply curve:¾ The aggregate supply curve shows the relationship between the price level and the aggregate amount of output that firms supply.13-18The AS Curve• The aggregate supply curve:¾ In the short run, prices remain fixed, so firms supply whatever output is demanded.• The short-run aggregate supply curve is horizontal.¾ This does NOT mean that P is exogenous.• Prices are pre-determined by events in prior time periods.• The assumption is based on the observation that in the short-run both prices and wages are sticky.13-19The AS Curve• The aggregate supply curve:¾ In the long run, firms supply the full-employment level of output, which is not affected by the price level.• The long-run aggregate supply curve is vertical.513-20The SRAS and LRAS CurvesYP13-21The SRAS Curve• Factors that shift the SRAS curve:¾ The SRAS curve shifts up (higher) with:• Excess demand in the prior time period, and/or• Increased costs of production (that cause higher prices).– Sharp changes in input costs:» Exogenous increases in wages,» Increases in commodity prices,» Increases in imported goods prices, especially oil, and/or» Decreases in productivity.13-22An increase in imported goods pricesYP13-23The LRAS Curve• Factors that shift the LRAS curve:¾ The LRAS curve shifts right with:• Increases in productivity,• Increases in labor supply, and/or• Increases in the capital stock.¾ that increase the full-employment level of output.613-24An increase in productivityYP13-25The AD-AS Model• Equilibrium in the AD-AS model:¾ Short-run equilibrium: AD intersects SRAS.¾ Long-run equilibrium: AD intersects LRAS.¾ General equilibrium: AD, LRAS, and SRAS all intersect at same point.13-26Equilibrium in the AD-AS modelYP13-27Aggregate Demand and Aggregate Supply• Equilibrium in the AD-AS model:¾ If the economy is not in general equilibrium, economic forces work to restore general equilibrium both in AD-AS diagram and
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