C15: AD and AS

C15: AD and AS

1. An increase in GPL with no change in money ss shifts the money dd curve rightward and raises the equilibrium i/r

   • difference btwn AD and normal dd curve: AS curve tells us the lvl of o/p at which total spending equals total o/p. It is not simply the total dd. For dd curve, a rise in price cause qty dd to decrease, but for as, a rise in GPL causes prices of all goods to increase tgt, no relatively cheaper goods to switch to. Along the AD curve, an increase in the price lvl raises the i/r in the money mkt, which decreases spending on interest sensitive goods, cause a drop in equi GDP.
     • P increase -> increase in money dd -> i/r increase -> A and IP decrease -> via multiplier, equi GDP decrease.
       • Change in GPL causes a move along AD curve, AD shifts rightward when govt purchases, I spending, autonomous C, net exports or money ss increase, or when net taxes decrease.

2. AS

   • 1. Firms set prices of their products as markup over their cost per unit. 2.
     • GDP affects unit costs because 1. greater inputs needed, prices of nonlabor inputs rise, nominal wage rate rises.
       • For SR analysis, we assume that changes in o/p have no effect on nominal wage rate cause of sticky wages. A rise in real GDP increases unit costs, which given a stable average markup in the economy, causes the price lvl to rise, a decrease in real GDP causes unit costs to fall, causes GPL to drop.
         • Real gdp increase, input requirements per unit of o/p increase + prices of nonlabour inputs increase, unit costs increase, prive lvl increase. (Movements along AS)
           • In ss curve, price changes o/p, for as curve, o/p changes price. // for ss curve, we assume prices of inputs remain fixed, increase in production of a single good unlikely to have much effect on input prices in the economy as a whole. But when we draw AS curve, increase in real GDP in which all firsm increase their o/p, this significantly raise the dd for inputs and hence increase in input prices
   • Shift in AS: 1. Changes in oil prices 2. changes in weather 3. tech change 4. nominal wage.

3. DD and SS shock

   • DD shock: event that causes AD to shift. 1. Increase in G, fiscal policy and crowding out, increase in money ss.
     • If a dd shock pulls the economy away from full employment, changes in the wage rate and price lvl will eventually cause the economy to correct itself and return to FE o/P. ( positive dd shock, shift AS to the right, increasing P and Y, when Y> Yfe, wage rate increase, unit cost increases, AS curve shifts upwards, P increases again and Y decreases until it reaches Yfe again.
       • In the LR, dd shocks can affect price lvl but not o/p. It is a LR AS curve, which is vertical.
   • G increases, then GDP increase. -> unit costs increase, price increase, money dd increase, i/r increase, A and IP decrease, GDP decrease. GDP still increase, but by less due to price increase.
     • When govt purchases increase, AS curve shifts right, it measures how much real GDP would increase if the price lvl remained constant. But with constant money ss, rise in P lvl causes RGDP to rise by less than the horizontal shift of AS curve.
   • In the SR, negative ss shock shifts AS curve upward, decreasing o/p and increase GPL. (increase in oil prices) it causes Stagflation in the SR. It is a combination of falling o/p and rising prices. In the LR, mkt self corrects, wage rage falls causing unit cost to fall and the AS curve will shift back to its original position.