ADAS Equilibrium IB Economics Putting AD and AS

AD/AS Equilibrium IB Economics

Putting AD and AS together Price Level SRAS AD Y 1 Real GDP

Price Level Equilibrium Price and Output Levels SRAS Q: What are the equilibrium price level & output? P 2 P P 1 AD Y 1 Real GDP

Price Level Equilibrium Price and Output Levels SRAS Q: What would eventually happen to the price level & output if the initial price level were P 2 rather than P? A: Excess supply of goods & services. Inventories are building up. To reduce the inventory levels, Firms will cut prices and output. The price level will fall & real output will decrease. Q: Why would this happen? P 2 A: B/c higher inventories will cause sellers to P P 1 reduce prices; lower prices will provide fewer incentives to increase production. However, consumers will purchase more output at lower prices. AD Y 1 Real GDP

Price Level Equilibrium Price and Output Levels SRAS Q: What would eventually happen to the price level & output if the initial price level were P 1 rather than P? A: Excess demand of goods & services. Inventories are below intended levels. Firms will seek to increase inventory levels, prices will rise & output will increase. Q: Why would this happen? P 2 A: B/c competition among buyers will P P 1 increase the price level; increased prices will encourage producers to increase their output & consumers will buy less. AD Y 1 Real GDP

Price Level Changes in the Equilibrium Price & Output Levels Middle Class Tax Cut Congress passes a tax cut for the middle class, and the president signs it. SRAS Price Level: ↑ ↓ n/c Real GDP: ↑ ↓ n/c AD Y 1 Real GDP

Price Level Changes in the Equilibrium Price & Output Levels Increased Gov’t Spending During a recession, the government increases spending on schools, highways, & other public works. SRAS Price Level: ↑ ↓ n/c Real GDP: ↑ ↓ n/c AD Y 1 Real GDP

Price Level Changes in the Equilibrium Price & Output Levels New Oil Discoveries New oil discoveries cause large decreases in energy prices. SRAS Price Level: ↑ ↓ n/c Real GDP: ↑ ↓ n/c AD Y 1 Real GDP

Price Level Changes in the Equilibrium Price & Output Levels Effects of an Increase in AD Illustrate the effects of an increase in aggregate demand. SRAS Price Level: ↑ ↓ n/c Real GDP: ↑ ↓ n/c AD Y 1 Real GDP

Price Level Changes in the Equilibrium Price & Output Levels Effects of Increases in Productions Costs Illustrate the effects of increases in production costs SRAS Price Level: ↑ ↓ n/c Real GDP: ↑ ↓ n/c AD Y 1 Real GDP

Price Level Changes in the Equilibrium Price & Output Levels Effects of New Technology & Better Education New technology and better education increase productivity SRAS Price Level: ↑ ↓ n/c Real GDP: ↑ ↓ n/c AD Y 1 Real GDP

Price Level Changes in the Equilibrium Price & Output Levels Increased Confidence for Future Economy A new president makes consumers & business more confident about the future economy. NOTE: Show the Change in AD only. SRAS Price Level: ↑ ↓ n/c Real GDP: ↑ ↓ n/c AD Y 1 Real GDP

Price Level Changes in the Equilibrium Price & Output Levels Reduced Taxes and Increased Government Spending W/the unemployment rate at 5%, the federal government reduces personal taxes & increases spending. NOTE: Show the change in AD only. SRAS Price Level: ↑ ↓ n/c Real GDP: ↑ ↓ n/c AD Y 1 Real GDP

Business Cycle/Fluctuations in Real GDP PEAK Real GDP Contractionary/ Recession Inflationary Gap Expansionary nd tre n -ru DP G l ea of r g Lon Recessionary Gap Contractionary/ Recession TROUGH Full Employment Periods of Time

Below Full Employment Equilibrium (Unemployment Equilibrium) LRAS SRAS 1 Price Level Recessionary gap AD 1 Qfe real GDP

Above Full Employment Equilibrium Price Level LRAS Inflationary gap SRAS 1 AD 1 Qfe real GDP

Recessions and Cyclical Unemployment n n n Decrease in AD Deflation – rare Prices “Sticky” Downward: q q q Wages Morale, effort, productivity Minimum wage Menu costs Fear of price wars

AD/AS and Inflation n Demand-Pull Inflation: AD shift n Cost-Push Inflation AS shift

Now Time to practice…