Macroeconomic EquilibriumThe AD-AS Model

Aggregate Demand

• Just as we can determine a demand curve for a particular good or service, we can also determine an Aggregate Demand Curve that represents demand in the macro economy

• In this case, it is the demand for a certain level of output (GDP) at a particular price level

Shift in Aggregate Demand

• Changes in Expectations– Greater optimism leads to more spending at any

given price level

• Changes in Wealth– As household assets increase in value, people feel

free to spend more at any given price level

Figure 17.2 Shifts of the Aggregate Demand CurveRay and Anderson: Krugman’s Macroeconomics for AP, First EditionCopyright © 2011 by Worth Publishers

Short-Run Aggregate Supply(SRAS)

• Upward sloping, just as in market case– But again for different reasons

• Profits = Price of Outputs – Price of Inputs– Revenue generated by price increases outpaces

increases in input costs (wages are “sticky”)– So, in the short-run curve slopes upwards

• Reverse is also true

Changes in SRAS1. Changes in commodity prices

– Oil; steel– Decrease in commodity prices = increase in SRAS

2. Changes in nominal wages– Increase in nominal wages = decrease in SRAS

3. Change in productivity– Increases in productivity = increase in SRAS

Figure 18.2 Shifts of the Short-Run Aggregate Supply CurveRay and Anderson: Krugman’s Macroeconomics for AP, First EditionCopyright © 2011 by Worth Publishers

Long-Run Aggregate Supply(LRAS)

• In the longer term, “sticky” input prices “catch up” to output prices

• Therefore, in the long run, price level should have no affect on aggregate supply

• So, aggregate supply would be a vertical line

Long-Run Aggregate Supply

• What is the significance of the output value (Y) at which the LRAS is vertical?

• The answer is the economy’s potential output– YP

– This represents the level at which the economy would produce if all prices (including wages) were perfectly flexible

Figure 18.4 Actual and Potential Output from 1989 to 2009Ray and Anderson: Krugman’s Macroeconomics for AP, First EditionCopyright © 2011 by Worth Publishers

Figure 19.4 Long-Run Macroeconomic EquilibriumRay and Anderson: Krugman’s Macroeconomics for AP, First EditionCopyright © 2011 by Worth Publishers

Long-Run Macroeconomic Equilibrium