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Cobbe ECO2013 F03 Chapter 8 Page 1 of 8 < When you have completed your study of this chapter, you will be able to C H A P T E R C H E C K L I S T Sketch the aggregate supply-aggregate demand ( AS-AD ) model and explain how real GDP and unemployment fluctuate in a business cycle. 1 Explain the forces that determine potential GDP and the functional distribution of income between labor and other factors of production. Explain what creates unemployment when the economy is at full employment and describe the influences on the natural unemployment rate. 2 3 Macroeconomists divide the variables that describe macroeconomic performance into two lists: Real variables Nominal variables When the economy is operating at full employment , the forces that determine the real variables are independent of those that determine the nominal variables. Away from full employment , real and monetary forces interact to bring economic fluctuations. UNDERSTANDING MACROECONOMIC PERFORMANCE 8.1 THE AS-AD MODEL The forces that determine potential GDP provide the anchor around which real GDP fluctuates in a business cycle. The AS-AD model explains the fluctuations around potential GDP. This is a very broad, metaphor-like, model, that gives us a story with which to understand the macroeconomy’s behavior. The AS-AD model has three components: Aggregate supply Aggregate demand Macroeconomic equilibrium 8.1 THE AS-AD MODEL < Aggregate Supply Potential GDP Potential GDP is the level of real GDP that the economy would produce if it were at full employment. 8.1 THE AS-AD MODEL Aggregate supply The relationship between the quantity of real GDP supplied and the price level when all other influences on production plans remain the same. Other things remaining the same, the higher the price level, the greater is the quantity of real GDP supplied, and the lower the price level, the smaller is the quantity of real GDP supplied.
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