As/Ad Model

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Macroeconomics – Chapter 10: The Aggregate Demand/Aggregate Supply Model * Keynesian Economics – Economists who focused on the short run * John Maynard Keynes - their leading advocate
* the originator of macroeconomics as a separate discipline from micro * Classical Economists – economists who focused on long-run issues such as growth * Aggregate Demand Management – government’s attempt to control the aggregate level of spending in the economy * Equilibrium Income – the level of income toward which the economy gravitates in the short run because of the cumulative cycles of declining or increasing production * Potential Income – the level of income that the economy is technically capable of producing without generating accelerating inflation * Paradox of Thrift – and increase in savings can lead to a decrease in expenditures, decreasing output and causing a recession * Multiplier Model – the model that was meant to capture Keynesian economics * This model emphasized aggregate output fluctuations

* Explored why those output fluctuations generally would not lead to wild fluctuations in output – depressions * Instead lead to smaller fluctuations – recessions
* The AS/AD Model – aggregate supply/aggregate demand
* Is a pedagogical model – designed to give a framework to organize thinking about macro economy * Does not focus on problems that occur because of interactions between individuals * Consists of 3 curves

* Short-run aggregate supply (SAS) curve
* Aggregate demand (AD) curve
* Long-run aggregate supply (LAS) curve – highest sustainable level of output * The price level of all goods is on the vertical axis and the aggregate output is on the horizontal axis * It is a historical model – starts at one point in time and says what will likely happen when changes affect the economy * Aggregate expenditures (demand) – the sum of consumption, investment, government spending, and net exports – p.234

* Discuss the historical development of macroeconomics
* The depression began in the 1930s and lasted 10 years * During the depression output fell by 30% and unemployment rose to 25% * This was the beginning of macro’s focus on the demand side of economics * Keynes started asking what short run forces were causing the Depression and what society could do to counteract them * This created the framework that focuses on short-run issues such as business cycles and how to stabilize output fluctuations * By the 1950s, Keynesian economics had been accepted by most economists and taught almost everywhere in the US * In the 1970s inflation became a serious issue which meant that the multiplier model was not very helpful * It assumed that the price level is fixed

* The standard model taught in macro then shifted to the Aggregate Supply/Aggregate Demand (AS/AD) model

* Explain the shape to the aggregate demand curve and what factors shift the curve * Aggregate demand (AD) curve – a curve that shows how a change in price level will change aggregate expenditures on all goods and services * It is downward-sloping

* The reasons for the downward slope are due to the: * Interest rate effect – the effect that a lower price level has on investment expenditures through the effect that a change in the price level has on interest rates – p.234 * International effect – as the price level falls (assuming the exchange rate does not change), net exports will rise – p.234 * Money wealth effect (real balance effect) – a fall in the price level will make the holders of money richer, so they buy more – p.234 * The multiplier effect strengthens each of these effects * Multiplier effect - the amplification of initial changes in expenditures – p.235 * Shifts in the AD curve – means...
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