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Chapter 14 Appendix The Self-Correcting Aggregate Demand and Supply Model

Chapter 14 Appendix The Self-Correcting Aggregate Demand and Supply Model. Survey of Economics Irvin B. Tucker. Lecture Slides. What will I learn in this appendix?. An understanding of long-run equilibrium using the self-correcting AD-AS model.

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Chapter 14 Appendix The Self-Correcting Aggregate Demand and Supply Model

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  1. Chapter 14 AppendixThe Self-Correcting Aggregate Demand and Supply Model Survey of EconomicsIrvin B. Tucker Lecture Slides

  2. What will I learn in this appendix? • An understanding of long-run equilibrium using the self-correcting AD-AS model

  3. What is the short-run aggregate supply curve (SRAS) • The curve that shows the level of real GDP produced at different possible price levels during a period of time in which nominal incomes do not change in response to changes in the price level

  4. Why is the short-run aggregate supply curve upward sloping? • Nominal wages and salaries (incomes) remain fixed in the short run as the price level changes

  5. Exhibit 14A.1(a) Short-run aggregate supply curve 200 SRAS B 150 Price level (CPI) A 100 C 50 Full employment 0 2 4 6 10 12 14 16 8 Real GDP (trillions of dollars per year)

  6. What is thelong-runaggregate supply curve (LRAS)? • The curve that shows the level of real GDP produced at different possible price levels during a period in which nominal incomes change by the same percentage as the price level changes

  7. Why is the long-run aggregate supply curve vertical? • In the long run, sufficient time has elapsed for labor contracts to expire and wages and salaries can be renegotiated

  8. Exhibit 14A.1(b) Long-run aggregate supply curve LRAS 200 B 150 Price level (CPI) A 100 50 Full employment 0 2 4 6 10 12 14 16 8 Real GDP (trillions of dollars per year)

  9. What is equilibrium in the self-correcting AD-AS model? • Where AD intersects both the vertical LRAS and the SRAS

  10. Exhibit 14A.2 Self-Correcting AD-AS Model LRAS SRAS 200 150 Price level (CPI) E 100 50 AD Full employment 0 2 4 6 10 12 14 16 8 Real GDP (trillions of dollars per year)

  11. What is the impact of an increase in aggregate demand? • The SRAS curve shifts leftward as nominal incomes rise because firms are competing for labor when the economy operates beyond full employment • Over time, the economy self corrects to a higher price level at full-employment real GDP

  12. Exhibit 14.3 Adjustments to an Increase in Aggregate Demand Increase in aggregate demand Increase in price level and real GDP Nominal incomes rise SRAS shifts leftward Long-run equilibrium restored

  13. Exhibit 14A.3 Adjustments to an Increase in Aggregate Demand 300 SRAS200 LRAC 250 SRAS150 E4 SRAS100 200 E3 Price level (CPI) 150 E2 100 E1 AD2 50 Full employment AD1 0 2 4 6 10 12 14 16 8 Real GDP (trillions of dollars per year)

  14. What is the impact of a decrease in aggregate demand? • The SRAS curve shifts rightward as nominal incomes fall because unemployed workers are competing for jobs when the economy operates below full employment • Over time, the economy self corrects to a lower price level at full-employment real GDP

  15. Exhibit 14.4 Adjustments to a Decrease in Aggregate Demand Decrease in aggregate demand Decrease in price level and real GDP Nominal incomes fall SRAS shifts rightward Long-run equilibrium restored

  16. Exhibit 14A.4 Adjustments to a Decrease in Aggregate Demand 300 LRAS SRAS200 250 SRAS150 E1 SRAS100 200 E2 Price level (CPI) 150 E3 100 E4 AD1 50 Full employment AD2 0 2 4 6 10 12 14 16 8 Real GDP (trillions of dollars per year)

  17. What is the conclusion? • A rightward shift of the LRAS curve represents economic growth in potential full-employment real GDP

  18. What causes increases in the LRAS curve? • Changes in resources • An advance in technology

  19. Exhibit14.5 Trend of macro equilibrium price level over time LRAS2015 LRAS2010 SRAS2015 SRAS2010 LRAS2005 Trend Line E3 Price level (CPI) SRAS2005 AD2015 E2 AD2010 E1 AD2005 Real GDP (trillions of dollars per year)

  20. Economic growth between 1995 and 2000 • In 1995, the economy was below its full-employment potential • Over five years, the economy grew to full employment with mild inflation • Technological change and capital accumulation caused economic growth in potential real GDP • AD increased and SRAS increased

  21. Exhibit 14A.6 A Rightward Shift in the Aggregate Demand and Long-run Aggregate Supply Curves Increase in aggregate demand and long-run supply Increase in price level and real GDP Long-run equilibrium restored SRAS shifts leftward Nominal incomes rise

  22. Exhibit 14A.6 A Rightward Shift in the Aggregate Demand and Long-run Aggregate Supply Curves LRAC95 LRAC00 Price level (CPI) SRAS00 E3 175 SRAS95 E2 152 E1 AD00 AD95 // // 8.3 0 9.8 8.0 Real GDP (trillions of dollars per year)

  23. END

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