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 AD-AS model is a variable price model.
 AD-AS model provides insights
   ▪ Inflation
   ▪ Unemployment
   ▪ economic growth.
• It shows an inverse relationship
  between price level and real
  domestic output.
• The explanation of the inverse
  relationship is not the same as
  for demand for a single product,
  which centered on substitution
  and income effects.
• a.    Substitution effect doesn’t
  apply within the scope of
  domestically produced goods,
  since there is no substitute for
  “everything.”
• b.    Income effect also doesn’t
  apply in the aggregate case,
  since income now varies with
  aggregate output.
 Real balances effect: When price level falls, the purchasing power
  of existing financial balances rises, which can increase spending.
  (think savings accounts)
 Interest‑ rate effect: A decline in price level means lower interest
  rates that can increase levels of certain types of spending. (thing
  home purchases)
 Foreign purchases effect: When price level falls, other things
  being equal, Philippines prices will fall relative to foreign prices,
  which will tend to increase spending on Philippines exports and
  also decrease import spending in favor of Philippines products that
  compete with imports.
 All of these dive the demand slope downward.
 Determinants are the
  “other things” (besides
  price level) that can
  cause a shift or change in
  demand (see Figure 11-2
  in text). Effects of the
  following determinants
  are discussed in more
  detail in the text.
 Two things cause shifts.
     A. determinates
     B. the multiplier effect
   Changes in consumer         Changes in investment
    spending, which can be       spending, which can be
    caused by changes in         caused by changes in
    several factors.             several factors.
   a. Consumer wealth          a. Interest rates,
   b. Consumer                 b. Expected returns,
    expectations                 which are a function of
   c. Household                Expected future business
    indebtedness                 conditions
   d. Taxes                    Technology
                                Degree of excess
   Changes in government        capacity
    spending.                   Business taxes
• Changes in net export spending unrelated to
  price level, which may be caused by changes in
  other factors such as
• a. National income abroad
• b. Exchange rates: Depreciation of the peso
  encourages Philippine exports since Philippine
  products become less expensive when foreign
  buyers can obtain more dollars for their currency.
   Conversely, peso depreciation discourages
  import buying in the Philippines because our
  peso can’t be exchanged for as much foreign
  currency.
   Aggregate supply is a
    schedule or curve
    showing the level of
    real domestic output
    available at each
    possible price level.
 1. In the long run the
  aggregate supply curve
  is vertical at the
  economy’s full-
  employment output.
 2. The curve is vertical
  because in the long run
  resource prices adjust to
  changes in the price
  level, leaving no
  incentive for firms to
  change their output.
• 1. The short-run aggregate supply curve is upward sloping.
• 2. The lag between product prices and resource prices makes it
  profitable for firms to increase output when the price level rises.
• 3.    To the left of full-employment output, the curve is relatively
  flat. The relative abundance of idle inputs means that firms can
  increase output without substantial increases in production costs.
• 4. To the right of full-employment output the curve is relatively
  steep. Shortages of inputs and production bottlenecks will require
  substantially higher prices to induce firms to produce.
• 5.    References to “aggregate supply” in the remainder of the
  chapter apply to the short-run curve unless otherwise noted.
•   1. A change in input prices, which
    can be caused by changes in several
    factors.
    ▫   a. Domestic resource prices
    ▫   b. Prices of imported resources
    ▫   c. Market power in certain industries
• 2.     Changes in productivity
  (productivity = real output / input) can
  cause changes in per-unit production
  cost (production cost per unit = total
  input cost / units of output). If
  productivity rises, unit production costs
  will fall. This can shift aggregate
  supply to the right and lower prices.
  The reverse is true when productivity
  falls. Productivity improvement is very
  important in business efforts to reduce
  costs.
• 3.     Change in legal‑institutional
  environment, which can be caused by
  changes in other factors.
    ▫   a. Business taxes and/or subsidies
    ▫   b. Government regulation
• Increases in aggregate
  demand increase real output
  and create upward pressure
  on prices, especially when the
  economy operates at or
  above its full employment
  level of output.
• 2. The multiplier effect
  weakens the further right the
  aggregate demand curve
  moves along the aggregate
  supply curve. More of the
  increase in spending is
  absorbed into price increases
  rather than generating
  greater real output.
•   Wage contracts are not
    flexible so businesses can’t
    afford to reduce prices.
•   Employers are reluctant to cut
    wages because of impact on
    employee effort, etc.
    Employers seek to pay
    efficiency wages – wages that
    maximize work effort and
    productivity, minimizing cost.
•   Minimum wage laws keep
    wages above that level.
•   Menu costs are difficult to
    implement.
•   Fear of price wars keeps prices
    from being reduced.
 1. Leftward shift in
  curve illustrates cost‑push
  inflation (see Figure 11-9).
 2. Rightward shift in
  curve will cause a decline
  in price level (see Figure
  11-10). See text for
  discussion of this
  desirable outcome.
 3. In the late 1990s,
  despite strong increases
  in aggregate demand,
  prices remained relatively
  stable (low inflation) as
  aggregate supply shifted
  right (productivity gains).


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Introduction to ad as model

  • 2.  AD-AS model is a variable price model.  AD-AS model provides insights ▪ Inflation ▪ Unemployment ▪ economic growth.
  • 3.
  • 4. • It shows an inverse relationship between price level and real domestic output. • The explanation of the inverse relationship is not the same as for demand for a single product, which centered on substitution and income effects. • a. Substitution effect doesn’t apply within the scope of domestically produced goods, since there is no substitute for “everything.” • b. Income effect also doesn’t apply in the aggregate case, since income now varies with aggregate output.
  • 5.  Real balances effect: When price level falls, the purchasing power of existing financial balances rises, which can increase spending. (think savings accounts)  Interest‑ rate effect: A decline in price level means lower interest rates that can increase levels of certain types of spending. (thing home purchases)  Foreign purchases effect: When price level falls, other things being equal, Philippines prices will fall relative to foreign prices, which will tend to increase spending on Philippines exports and also decrease import spending in favor of Philippines products that compete with imports.  All of these dive the demand slope downward.
  • 6.  Determinants are the “other things” (besides price level) that can cause a shift or change in demand (see Figure 11-2 in text). Effects of the following determinants are discussed in more detail in the text.  Two things cause shifts.  A. determinates  B. the multiplier effect
  • 7. Changes in consumer  Changes in investment spending, which can be spending, which can be caused by changes in caused by changes in several factors. several factors.  a. Consumer wealth  a. Interest rates,  b. Consumer  b. Expected returns, expectations which are a function of  c. Household  Expected future business indebtedness conditions  d. Taxes  Technology  Degree of excess  Changes in government capacity spending.  Business taxes
  • 8. • Changes in net export spending unrelated to price level, which may be caused by changes in other factors such as • a. National income abroad • b. Exchange rates: Depreciation of the peso encourages Philippine exports since Philippine products become less expensive when foreign buyers can obtain more dollars for their currency. Conversely, peso depreciation discourages import buying in the Philippines because our peso can’t be exchanged for as much foreign currency.
  • 9. Aggregate supply is a schedule or curve showing the level of real domestic output available at each possible price level.
  • 10.  1. In the long run the aggregate supply curve is vertical at the economy’s full- employment output.  2. The curve is vertical because in the long run resource prices adjust to changes in the price level, leaving no incentive for firms to change their output.
  • 11. • 1. The short-run aggregate supply curve is upward sloping. • 2. The lag between product prices and resource prices makes it profitable for firms to increase output when the price level rises. • 3. To the left of full-employment output, the curve is relatively flat. The relative abundance of idle inputs means that firms can increase output without substantial increases in production costs. • 4. To the right of full-employment output the curve is relatively steep. Shortages of inputs and production bottlenecks will require substantially higher prices to induce firms to produce. • 5. References to “aggregate supply” in the remainder of the chapter apply to the short-run curve unless otherwise noted.
  • 12. 1. A change in input prices, which can be caused by changes in several factors. ▫ a. Domestic resource prices ▫ b. Prices of imported resources ▫ c. Market power in certain industries • 2. Changes in productivity (productivity = real output / input) can cause changes in per-unit production cost (production cost per unit = total input cost / units of output). If productivity rises, unit production costs will fall. This can shift aggregate supply to the right and lower prices. The reverse is true when productivity falls. Productivity improvement is very important in business efforts to reduce costs. • 3. Change in legal‑institutional environment, which can be caused by changes in other factors. ▫ a. Business taxes and/or subsidies ▫ b. Government regulation
  • 13.
  • 14. • Increases in aggregate demand increase real output and create upward pressure on prices, especially when the economy operates at or above its full employment level of output. • 2. The multiplier effect weakens the further right the aggregate demand curve moves along the aggregate supply curve. More of the increase in spending is absorbed into price increases rather than generating greater real output.
  • 15. Wage contracts are not flexible so businesses can’t afford to reduce prices. • Employers are reluctant to cut wages because of impact on employee effort, etc. Employers seek to pay efficiency wages – wages that maximize work effort and productivity, minimizing cost. • Minimum wage laws keep wages above that level. • Menu costs are difficult to implement. • Fear of price wars keeps prices from being reduced.
  • 16.  1. Leftward shift in curve illustrates cost‑push inflation (see Figure 11-9).  2. Rightward shift in curve will cause a decline in price level (see Figure 11-10). See text for discussion of this desirable outcome.  3. In the late 1990s, despite strong increases in aggregate demand, prices remained relatively stable (low inflation) as aggregate supply shifted right (productivity gains).
  • 17.