The as ad aggregate supply aggregate demand model 21

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Where are we going? The AS-AD (aggregate supply - aggregate demand) model . 21 Inflation ( ) 0 Output ( Y ) AD (aggregate demand) SRAS (short run aggregate supply) LRAS (long run aggregate supply) Y*
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2. AS - AD Model: Aggregate Demand . 22 0 Output ( Y ) Inflation ( ) AD (aggregate demand) AD: relates demand to the rate of inflation Constructed from a series of equilibrium points (for each level of inflation)
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Why does higher inflation lead to lower PAE (and equilibrium output) or why does AD have a negative slope? Consider Inflation and interest rates: when exceeds the RBA target, the RBA will react by raising interest rates to reduce AD (move along RBA policy reaction function) visa versa Inflation and wealth (lower wealth => lower consumption) Inflation and income distribution (greater impact on less affluent who spend greater proportion of income => impact overall spending) Inflation and uncertainty (uncertainty =>pessimistic expectations) Inflation and international competitiveness (inflation increases real exchange rate (Pd/Pf) x e and reduces competitiveness) 23
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Why does equilibrium level of output change, at a given level of inflation what causes shifts in the aggregate demand curve? AD shifts due to: Exogenous changes in components of PAE [ = C + Ip + G + NX ] Expectations, Fiscal policy, world output and other economic conditions Shift in the RBA policy reaction function (RBA decides to change how they want to react to a given inflation rate reflected terms of a higher or lower nominal and real interest rate at any given rate of inflation 24
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2. AS - AD Model: Aggregate Demand . 25 0 Output ( Y ) Inflation ( ) AD (aggregate demand)
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Aggregate Demand - and a shift in RBA’s policy reaction function . 26 r as set by RBA 0 inflation ( ) inflation ( ) Output ( Y ) old policy reaction function AD AD’ new policy reaction function
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3. AS-AD Model: Inflation and Aggregate Supply Aggregate supply - relationship between output and inflation Aggregate supply differs between short run and the long run Short run: producers supply whatever output is demanded (at pre existing prices); inflationary expectations are reasonably constant Long run: supply determined by potential output; Y* = f ( labour, capital, technology) does not depend on inflation rate 27
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Aggregate Supply differs in short run (SRAS) and long run (LRAS) . 28 Inflation ( ) 0 Output ( Y ) SRAS (short run aggregate supply) LRAS (long run aggregate supply) Y*
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Aggregate Supply differs in short run (SRAS) and long run (LRAS) . 29 Inflation ( ) 0 Output ( Y ) SRAS (short run aggregate supply) LRAS (long run aggregate supply) Y*
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