Chapter 6.pdf - CHAPTER 6 A model for an inflationary...

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CHAPTER 6A model for an inflationary economy:
OutcomesUse the aggregate demand (AD) and aggregate supply (AS) model to explain bothfluctuations in real GDP (Y) and changes in theaverage price level (P).Analyse and assess the importance of the medium-run supply adjustment process towards a long-run, structural equilibrium and a long-run AS curveCompose complex chain reactions for an open economy which include effects on the price level together with real GDP (Y).Evaluate these chain reactions with appropriate graphical aids..
IntroductionIn the Keynesian model (chapters 2 4) averageprice levels and inflation was considered to beconstant.Keynesian theory was developed during the Great Depression, experienced highunemployment.Focus is thus only on real income (Y) andunemployment.The IS/LM/BP curves illustrated the relationshipbetween real income (Y) and real interest rates (r).AD/AS curves illustrate the relationship between real income (Y) and average price levels (P) (inflation).
Basic termsTypes of unemploymentSeasonal unemploymentdue to seasonalpatterns of increased or decreasedactivityin certain sectors of the economy.Frictional unemploymentdue to a certain number of people who are intheprocessof searching for new jobs or busychanging jobs or careers.Cyclical unemploymentdue to the short-run cyclicaldownswings in the levelof macroeconomicactivityas the GDP or Y level fluctuate so do employmentfluctuate.Structural unemploymentarises from the nature, location andpattern ofemployment opportunities. Due to the mismatches between workerskills andskillsrequirements of available jobs.Natural rate of unemploymentthe long-run unemployment rate.
6.1 Essentials of the AD/AS modelIn Keynesian model (chapters 2 4) the assumption was made that:1.The supply side will respond effortlessly to any change in demand.2.Price level are constant.These assumptions will be relaxed in the AD/AS model.AD/AS model recast the real and monetary sectors in one diagram that explicitly isolates the average price level as a variable on one axis.It also provide additional information regarding the behaviour of firms and workers on the production, or supply side of the economy.The 45̊diagram and IS/LM/BP diagram are collapsed into one curve, the AD curve and has a negative slope.The AS curve represent the supply side of the economy has positiveslope.The intersection of AD/AS curves illustrate the equilibrium real income and average price level.AS curve will be divided into ashort-run (ASSR) and long-run (ASLR).
6.2 Aggregated demand (AD)Def:Illustrate all combinations of real income(Y) and the average price level (P) at which there would be simultaneous equilibrium in the real and monetary sectors.

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