Unit 3: AS/AD Model

The AS/AD Model

• The equilibrium of AS & AD determines current output (GDPR) and the price level (PL)

Full Employment

• Equilibrium exists where AD intersects SRAS & LRAS at the same point 

Recessionary Gap

• Exists when equilibrium occurs below full employment output

Inflationary Gap

• When equilibrium occurs beyond full employment output

▲in AD: 

• ▲Consumption (C)
• C↑ ∴ AD → ∴ GDPR↑ and PL↑ ∴ u%↓ and π%↑
• C↓ ∴ AD ← ∴ GDPR↓ and PL↓ ∴ u%↑ and π%↓
• ▲ Gross Private Investment (Ig)
• Ig↑ ∴ AD → ∴ GDPR↑ and PL↑ ∴ u%↓ and π%↑
• Ig↓ ∴ AD ← ∴ GDPR↓ and PL ↓ ∴ u%↑ and π%↓
• ▲Government Spending (G)
• G↑ ∴ AD→ ∴ GDPR↑ and PL↑ ∴ u%↓ and π%↑
• G↓ ∴ AD← ∴ GDPR↓ and PL↓ ∴ u%↑ and π%↓
• ▲ Net Exports (Xn)
• Xn↑ ∴ AD→ ∴ GDPR↑ and PL↑ ∴ u%↓ and π%↑
• Xn↓ ∴ AD← ∴ GDPR↓ and PL↓ ∴ u%↑ and π%↓

Increase in AD

• C↑, Ig↑, G↑, and/or Xn↑ ∴ AD→ ∴ GDPR↑ and PL↑ ∴ u%↓ and π%↑

Decrease in AD

▲ in SRAS:

• ▲ Input Prices
• Input Prices↓ ∴ SRAS→ ∴ GDPR↑ and PL↓ ∴ u%↓ and π%↓
• Input Prices↑ ∴ SRAS← ∴ GDPR↓ and PL↑ ∴ u%↑ and π%↑
• ▲ Productivity
• Productivity↑ ∴ SRAS→ ∴ GDPR↑ and PL↓ ∴ u%↓ and π%↓
• Productivity↓ ∴ SRAS← ∴ GDPR↓ and PL↑ ∴ u%↑ and π%↑
• ▲ Legal-Institutional Environment
• Deregulation ∴ SRAS→ ∴ GDPR↑ and PL↓ ∴ u%↓ and π%↓
• Regulation ∴ SRAS← ∴ GDPR↓ and PL↑ ∴ u%↑ and π%↑

Increase in SRAS: 

• Input Prices↓, Productivity↑, and/or Deregulation ∴ SRAS→ ∴ GDPR↑ and PL↓ ∴ u%↓ and π%↓

Decrease in SRAS: 

• Input Prices↑, Productivity↓, and/or Regulation ∴ SRAS← ∴ GDPR↓ and PL↑ ∴ u%↑ and π%↑