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21 The AD - AS Model, Part 1-1

21 The AD - AS Model, Part 1-1 - Agenda Business Cycle...

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1 21-1 The IS – LM / AD – AS Model: A General Framework for Macroeconomic Analysis, Part 1 21-2 Agenda Business Cycle Analysis: A Preview. The Problem of Unemployment. The Problem of Inflation. 21-3 Business Cycle Analysis: A Preview What explains business cycle fluctuations? ¾ 2 major components of business cycle theories: A description of the shocks. A model of how the economy responds to shocks. ¾ 2 major business cycle theories: Classical theory. Keynesian theory. 21-4 Business Cycle Analysis: A Preview What explains business cycle fluctuations? ¾ Both theories can be studied in an aggregate demand-aggregate supply ( AD-AS ) framework. ¾ The AD-AS model has 3 main components: An aggregate demand ( AD ) curve, A short-run aggregate supply ( SRAS ) curve, and A long-run aggregate supply ( LRAS ) curve.
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2 21-5 Business Cycle Analysis: A Preview AD and AS —A brief introduction: ¾ The aggregate demand ( AD ) curve: Shows quantity of goods and services demanded ( Y ) for any price level ( P ). A higher P means less aggregate demand (lower Y ), The aggregate demand curve slopes downward. An increase in aggregate demand for a given P shifts the aggregate demand curve to the right. 21-6 The Aggregate Demand Curve 21-7 Business Cycle Analysis: A Preview AD and AS —A brief introduction: ¾ The short-run aggregate supply ( SRAS ) curve: The short-run aggregate supply curve shows how much output ( Y ) producers are willing to supply in the short- run at any given price level ( P ). The short-run aggregate supply curve is horizontal. We assume the prices are fixed in the short run. 21-8 The Short-run Aggregate Supply Curve
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3 21-9 Business Cycle Analysis: A Preview AD and AS —A brief introduction: ¾ The long-run aggregate supply ( LRAS ) curve: The long-run aggregate supply curve shows how much output ( Y ) producers are willing to supply in the long- run at any given price level ( P ). The long-run aggregate supply curve is vertical at the full-employment level of output. 21-10 The Long-run Aggregate Supply Curve 21-11 Business Cycle Analysis: A Preview AD and AS —A brief introduction: ¾ Equilibrium in the AD AS model: Short-run equilibrium : At the Y and P where the aggregate demand ( AD ) curve intersects the short-run aggregate supply ( SRAS ) curve. Long-run equilibrium : At the Y and P level where the aggregate demand ( AD ) curve intersects the long-run aggregate supply ( LRAS ) curve.
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