K Chapter 12, ASAD model (1).docx

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Chapter 12: The AS/AD model. All models are simplifications of reality. They include just what they must to get the point across. The closer they are to reality, the more complex they become so the harder to extract what you’re trying to find out. This BC model shows where we currently are, 18 T and where we’d like to be, 18 T (full employment). 18 T While this model has useful information, it does not have information on prices and that would be helpful. It also cannot show much detail about changes in spending or production. So we need another model. The AS/AD model is all about the relationship between total spending (C+I+G+Xn) and production (RGDP). In equilibrium, production and spending are equal, but otherwise inventories will rise and fall if spending is less than or greater than production. To keep that distinction clear, equilibrium income is defined as planned spending is equal to GDP. This relationship between spending and RGDP can be modeled! In fact, this model (the AS/AD model) is an income (RGDP) general price level determination model! This means that the forces of aggregate demand (spending) and aggregate supply (production) are going to work together to determine the level of RGDP and the GDP Price Index at which the economy is currently. Those two numbers are determined by the actions of buyers and sellers! Like all markets. RGDP Time Full employment Today

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If we add up all the FOUR spenders: C, I, G, and Xn. And we look at their behavior relative to price, we get the aggregate demand curve. If we add up the output from all the sellers and look at their behavior with respect to price, then we get aggregate supply. If we put those two together we get the AS/AD model! This is clearly very similar to the supply and demand model from chapter 3. Equilibrium income (RGDP) is defined as where total planned spending is equal to RGDP. That is, there is no change in inventories: all the goods that are produced this year are bought— no more and no less.
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