Week_6 - ECMA06 The AS-AD Model (continued) 1 The AS-AD...

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ECMA06 – The AS-AD Model (continued) 1 The AS-AD Model (continued) Outline The derivation of the aggregate supply (AS) curve. The adjustment mechanism of the AS-AD model. Consider the effect of a disturbance in the AS-AD model and its implications on government policy. Derivation of the Aggregate Supply (AS) We have already derived the AD curve. We need to derive the aggregate supply curve to complete the model. Recap, what do we learn about the AD? The AD curve indicates the equilibrium level of output on the demand side. In other words, the AD curve indicates, at each different price level , the level of output that generates just enough AE (C + I + G + X – IM) so that all the output gets purchased (remember we derived the AD curve by setting Y = AE).
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ECMA06 – The AS-AD Model (continued) 2 BUT , we need to consider what firms are willing to produce. What we have not captured is whether, at that price level , firms will indeed be willing to produce that level of output. Therefore, the aggregate supply (AS) curve should represent the amount of output that firms in the economy are willing to produce at each price level . Question: What we learned about marginal cost (MC) in micro suggests that AS should be upward sloping. Does it hold true for the economy as a whole? P Y Answer: Once again we are looking at the entire economy not just one industry, the big picture matters! Slope of the AS Curve
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ECMA06 – The AS-AD Model (continued) 3 Case 1: If There is a Lot of Unemployment, This means Y* is much lower than Y FE (Y* < Y FE ). If this is the case, we might expect that firms will be willing to supply more even if price does not increase much. The AS curve will be relatively flat (i.e., elastic) . Why? Since there are quite a large number of unemployed workers, firms would find it easy to hire workers if they want to expand. Besides, firms probably have laid off workers in the last little while and have unused facilities.
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ECMA06 – The AS-AD Model (continued) 4 Case 2: If There is a Not Much Unemployment, This means Y* is bigger than Y
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This note was uploaded on 06/18/2011 for the course ECMA 06 taught by Professor Dr.atamazaheri during the Spring '10 term at University of Toronto- Toronto.

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Week_6 - ECMA06 The AS-AD Model (continued) 1 The AS-AD...

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