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Week 7 + 8: The aggregate demand - aggregate supply model (Reasons for the…
Week 7 + 8: The aggregate demand - aggregate supply model
Reasons for the downward slope of AD curve
high inflation => reduces the purchasing power => reduces household spending
high inflation => RB will change the interest rate (increase) => less investment
high inflation => makes exports less competitive (because of the high prices) => decrease net export
low interest rate => low exchange rate
Shifts of the AD curve
Investment
Interest rate
Expected profit level
Government expenditure (exogenous change in policy reaction function)
contractionary fiscal policy
expansionary fiscal policy
Consumer spending (exogenous change in spending)
Net export
Aggregate supply
Inflation and supply decisions
Factors causing inflation rate
Output gap
Inflation gap
positive shock: lower inflation
negative shock: higher inflation (stagnation)
Shock to potential output
negative shock: natural disaster (higher inflation)
positive shock: technology (lower inflation)
Output gaps and inflation
Shifts of the AS curve
Changes in variable resources and technologies
Long- run equilibrium: always at the potential output level
In the long run if
output level < expected level
(economy is in
recession
) => wages and cost of production decrease (due to lower inflation rate) => increase supply => AS curve shift to the right => bring back economy to the expected output level