ADASmodel - 11/10/2010 1 The AD-AS model Juan Carlos...

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Unformatted text preview: 11/10/2010 1 The AD-AS model Juan Carlos Cordoba ISU November 2010 Economic Fluctuations Aggregate Demand and Aggregate Supply (AD-AS) Model y The ISLM model describes the economy in the ( r,Y ) plane (or space ). y Alternatively, one can describe economy in the ( P,Y ) plane. y Such representation is reminiscent of the ( P =price, Q =quantity) representation typical of microeconomics. y The ISLM model that uses the ( P,Y ) graph is called the AD-AS model (Aggregate Demand -Aggregate Supply model) y Both the ISLM and AD-AS describe the same model (the same economy) and therefore have exactly the same predictions. They just look at the same object (the economy) from two different perspectives. y Depending on the question, one approach or the other may be more convenient but both should lead to the same conclusions. 11/10/2010 2 LM 1 (P=P 1 ) LM (P P Derivation of the Aggregate Demand Curve r P r P r 1 P 1 LM 0 (P=P ) AD C (a) IS-LM Y Y IS Y (b) Aggregate Demand Curve Y Y 1 Y 1 AD Curve Why is the Aggregate Demand Curve Downward Slopping? y A traditional demand curve is downward slopping because individuals want to substitute goods which are relatively more expensive (relative to other goods). y In basic macro there is only one good ( Y ) and one price ( P ). y If P goes up, individuals do not have other choices, only Y . y In spite of this, we still find that the higher the price the lower the quantity demanded of the only good. Why? y A higher price reduces the real money supply which increases the real interest rate. y A higher interest rate reduces aggregate demand (both investment and consumption) 11/10/2010 3 Factors that Shift the AD curve y For a constant price (P), any factor that shift the intersection of the IS and LM curves to the right increases aggregate ouput demanded and shifts the AD curve up and to the right. 11/10/2010 4 The short run and long run aggregate supply curve level,P LRAS = Long Run Aggregate Supply Price P SRAS Short Run Aggregate Supply ) , ( N K zF Y = Output, Y Short run and long run equilibrium in AD AS model level,P LRAS Short Run Equilibrium (point where AD and SRAS intersect) Price P SRAS Long Run General Equilibrium A B Y Output, Y AD Equilibrium (Point where AD and LRAS intersect ) AD 1 11/10/2010...
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ADASmodel - 11/10/2010 1 The AD-AS model Juan Carlos...

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