Economics: AS and AD Models

Aggregate Output, Price Level, and Interest Rates

• Aggregate Supply (AS): Represents the total production of goods and services in an economy.
  • AS Curve: Shows the relationship between the price level and the quantity of output (Y).
  • Shape:
    • Flat (elastic): Economy has unused resources.
    • Steep (inelastic): Economy near full capacity.
    • Short-Run AS: Upward sloping due to sticky wages.
    • Long-Run AS: Vertical because wage adjustments ensure output remains at potential GDP (Yo).
  • Key Points:
    • Higher prices encourage more production in the short run as wages adjust slowly.
    • In the long run, wage adjustments balance increased revenues with higher costs, keeping output fixed at Yo.
  • Formulas:
    • Short-Run AS movements: Increase in price = Increase in output.
    • Shifts in AS: Caused by changes in input costs (like oil prices).

Aggregate Demand (AD)

• Definition: Total demand for goods and services in an economy.
• AD Curve: Downward sloping because:
  • Higher prices reduce purchasing power and demand.
  • Higher prices increase interest rates, decreasing investment.
• Factors Shifting AD:
  • Increase in AD: Higher consumption, investment, or government spending; lower taxes.
  • Decrease in AD: Opposite of the above factors; decline in consumer confidence.

IS-Fed Rule Model

• Definition: Relationship between interest rates (R) and aggregate output (Y).
• IS Curve: Downward sloping, Higher interest rate (R) leads to lower investment (I) and lower output (Y). Shifts caused by changes in G, C, I, or T.
• Fed Rule: Central bank's response to economic changes.
  • Formula: R = αY + ẞP + γZ (where R = interest rate, Y = output, P = price level, Z = other factors).

Long-Run Aggregate Supply (LRAS)

• Definition: Maximum sustainable output (Yo) regardless of the price level.
• Shape: Vertical.
• Shifts:
  • Increase in resources or productivity → Shift right.
  • Resource depletion → Shift left.
• Adjustments: Short-run shocks to AD affect output (Y) in the short run, but wage adjustments return Y to Yo in the long run.

Summary of Formulas

• Aggregate Supply:
  • Short-run: Prices increase → Output increases.
  • Long-run: Prices and wages adjust → Output = Yo.
• Aggregate Demand: AD = C + I + G.
  • Higher prices → Lower AD.

This quiz focuses on the concepts of Aggregate Supply (AS) and Aggregate Demand (AD) in economics. You'll explore the characteristics of the AS curve, how price levels affect output, and the interaction between wages and production. Test your understanding of these fundamental economic theories.