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    Macro8 AD As Longrun Lob

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    Ben Marks
    This document provides an introduction to aggregate demand and aggregate supply models in the long run and short run. It explains how aggregate demand is derived from the quantity theory of money and how aggregate supply is horizontal in the short run but vertical in the long run. Shifts in aggregate demand can cause changes in output and price levels depending on whether they are in the short run or long run. Fiscal and monetary policy can be used to shift aggregate demand to counteract economic fluctuations.

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    Macro8 AD As Longrun Lob

    Uploaded by

    Ben Marks
    27 views8 pages
    This document provides an introduction to aggregate demand and aggregate supply models in the long run and short run. It explains how aggregate demand is derived from the quantity theory of money and how aggregate supply is horizontal in the short run but vertical in the long run. Shifts in aggregate demand can cause changes in output and price levels depending on whether they are in the short run or long run. Fiscal and monetary policy can be used to shift aggregate demand to counteract economic fluctuations.

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    Economics peresentation.

    Original Title

    Macro8 AD as Longrun Lob

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    This document provides an introduction to aggregate demand and aggregate supply models in the long run and short run. It explains how aggregate demand is derived from the quantity theory of money and how aggregate supply is horizontal in the short run but vertical in the long run. Shifts in aggregate demand can cause changes in output and price levels depending on whether they are in the short run or long run. Fiscal and monetary policy can be used to shift aggregate demand to counteract economic fluctuations.

    Copyright:

    Attribution Non-Commercial (BY-NC)
    Download as PPT, PDF, TXT or read online from Scribd
    Download as ppt, pdf, or txt
    27 views8 pages

    Macro8 AD As Longrun Lob

    Uploaded by

    Ben Marks
    This document provides an introduction to aggregate demand and aggregate supply models in the long run and short run. It explains how aggregate demand is derived from the quantity theory of money and how aggregate supply is horizontal in the short run but vertical in the long run. Shifts in aggregate demand can cause changes in output and price levels depending on whether they are in the short run or long run. Fiscal and monetary policy can be used to shift aggregate demand to counteract economic fluctuations.

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    You are on page 1of 8

    Aggregate Demand and Aggregate Supply in the Long Run

    A brief introduction to business cycles

    Model Background

    This model uses the quantity equation as


    aggregate demand and assumes long run supply to be perfectly vertical and short run supply to be perfectly horizontal.

    If the model is out of equilibrium it is the changing


    price level that returns the model to equilibrium.

    Building Aggregate Demand


    The quantity theory of money says
    MV=PY

    Rearranging we get (M/P)=kY, where k


    = 1/V, so as P increases Y decreases

    If we map this out we get an AD


    function

    An increase in M or a decrease in k
    implies that for any given P, Y is higher, hence an outward shift of AD. Changing M is monetary policy. Also because Y = C + I + G + NX, demand side variables can shift AD as well. Changing G or T is fiscal policy.
    AD AD

    AD

    Similarly a decrease in M or increase in


    k would shift AD in.

    Building Aggregate Supply: long run


    In the long run output is
    determined by factor inputs (Y=F(K,L)) and is not dependent on price. Hence, long run aggregate supply is vertical.

    LRAS

    In this context a shift in AD causes


    a change in the price level but has no effect on Y.
    P*

    AD
    P*

    AD
    Y

    Building Aggregate Supply: short run


    In the short run price is fixed so
    the aggregate supply curve is horizontal.

    In this context a shift in AD causes


    a change in Y but has no effect on P.
    P*

    SRAS
    AD AD
    Y

    From the Short Run to the Long Run


    The economy begins in long run
    equilibrium at point 1.

    If aggregate demand shifts out,


    the economy moves from point 1 to point 2, above full employment output. As we approach the long run there is upward pressure on P. As P increases Y decreases and we move along AD to point 3.
    the natural level but P is permanently higher.
    P

    LRAS

    3 2
    P*

    SRAS

    The end result is that Y returns to

    AD AD
    Y

    Stabilization Policy
    Fluctuations in the economy can
    shift either AD or AS.

    Fiscal and monetary policies are


    able to shift AD. Because of this a shock to AD can be corrected with P and Y returning to their preshock levels. However if there were a supply shock then a policy adjustment would imply a trade off between Y or P. With a negative supply shock accommodating the shock would mean returning the economy to Y causing a higher P in the long run. The alternative would be to wait for the shock to pass.
    P

    LRAS

    SRAS
    P*

    SRAS
    AD AD AD
    Y

    Conclusion

    We constructed a basic AD/AS model. AD


    was derived from the quantity theory of money function. In the short run, P is sticky and SRAS is horizontal. In the long run factor inputs determine Y and P is variable so LRAS is vertical.

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