23 The AD - AS Model, Part 3

23 The AD - AS Model, Part 3 - 1 23-1 The IS-LM/AD-AS Model...

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Unformatted text preview: 1 23-1 The IS-LM/AD-AS Model: A General Framework for Macroeconomic Analysis, Part 3 23-2 Agenda • Price Adjustment and the Attainment of General Equilibrium 23-3 General equilibrium in the AD-AS model Y P SRAS LRAS P Y* AD 23-4 Disequilibrium in the AD-AS model • Equilibrium in the AD- AS model: ¾ If the economy is NOT in general equilibrium, economic forces will work to restore general equilibrium in both the IS-LM and AD-AS models. 2 23-5 Price Adjustment and General Equilibrium • Price adjustment in the IS-LM and AD-AS models: ¾ An increase in government purchases, ¾ An increase in the real money supply, ¾ A short-run adverse supply shock, and ¾ A long-run adverse supply shock. 23-6 Price Adjustment and General Equilibrium • An increase in government purchases: ¾ In Year 0, the economy is in general equilibrium. • Denote the general equilibrium level of output by Y*. 23-7 An increase in government purchases r Y Y P AD SRAS LRAS FE LM IS Y* Y* P r 23-8 Price Adjustment and General Equilibrium • An increase in government purchases: ¾ In Year 1, government purchases increase. • Assume Ricardian equivalence does NOT hold. • An increase in government purchases shifts both the IS and AD curves to the right . 3 23-9 Price Adjustment and General Equilibrium • An increase in government purchases: ¾ In Year 1, the increase in government purchases increases output but leaves the price level unchanged. • Short-run equilibrium is at: – The intersection of the IS and LM curves, and – The intersection of the AD and SRAS curves. • The labor market is temporarily out of equilibrium. – Employment has increased. – The unemployment rate has declined. 23-10 Price Adjustment and General Equilibrium • An increase in government purchases: ¾ In Year 2, the price level begins to rise. • In Year 2, the SRAS curve shifts up because of excess aggregate demand in Year 1, i.e., Y 1 > Y*. – How far the SRAS curve shifts up depends on the explicit price adjustment process for the economy. – Generally it is a multiyear process dependent on the amount of excess aggregate demand. 23-11 Price Adjustment and General Equilibrium • An increase in government purchases: ¾ In Year 2, the price level begins to rise. • A higher price level reduces the real money supply, M s /P. – Alternatively, the purchasing power of the nominal money supply, M s , has been reduced. • A lower real money supply shifts the LM curve to the left, raising the real interest rate. 23-12 Price Adjustment and General Equilibrium • An increase in government purchases: ¾ In Year 2, the price level begins to rise. • A higher real interest rate will: – Reduce interest-sensitive spending, – Reduce output and employment, and – Raise the unemployment rate. 4 23-13 Price Adjustment and General Equilibrium • An increase in government purchases: ¾ In Year 3, the price level continues to adjust up....
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This note was uploaded on 07/29/2010 for the course UGBA 100b taught by Professor Wood during the Summer '10 term at Berkeley.

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23 The AD - AS Model, Part 3 - 1 23-1 The IS-LM/AD-AS Model...

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