AD-AS Model - Part 1 - Explaining the three curves

Summary

This video explores the Aggregate Demand-Aggregate Supply (ADAS) model, explaining key concepts such as the components of aggregate demand, factors influencing both short-run and long-run aggregate supply, and the dynamic relationship between price levels, output, and potential GDP. It delves into how the business cycle causes fluctuations between expansions and recessions, and how factors like technology, productivity, and resources impact long-term economic growth. The video also covers government policies that influence aggregate demand and supply, providing a comprehensive understanding of how economies respond to changes in demand and supply.

Takeaways

• 😀 Short-run GDP fluctuations alternate between expansions and recessions, creating cycles in economic output.
• 😀 Potential GDP is the level of output an economy can sustain over the long term, with actual GDP fluctuating around it in the short run.
• 😀 Actual GDP can be above or below potential GDP depending on economic conditions, such as during recessions or expansions.
• 😀 The output gap measures the difference between actual GDP and potential GDP, with a negative gap indicating a recessionary period.
• 😀 Long-term economic growth can shift potential GDP upwards due to factors like technological progress, human capital, and resource availability.
• 😀 The potential GDP changes over time, unlike the short-term changes in actual GDP, which are more cyclical in nature.
• 😀 The ADAS model helps explain the economy's behavior in the short run (actual GDP) and long run (potential GDP).
• 😀 In the long run, the aggregate supply curve (LRAS) is vertical and represents the economy's potential output, which is not affected by input prices.
• 😀 The short-run aggregate supply curve is influenced by factors like changes in commodity prices, wages, and productivity.
• 😀 Recessionary periods, such as the one in 2009, demonstrate how actual GDP can significantly fall below potential GDP, showing a negative output gap.
• 😀 Potential GDP does not remain static; it evolves with improvements in productivity and technological advancements.

Q & A

What is the main purpose of the Aggregate Demand-Aggregate Supply (AD-AS) model?

The AD-AS model helps to explain how various economic factors influence real output and the overall price level in an economy, as well as how the economy reacts to short-term and long-term shocks.

What is the relationship between aggregate price level and the quantity of output demanded in the AD-AS model?

In the AD-AS model, there is typically a negative relationship between the aggregate price level and the quantity of output demanded. As the price level increases, the quantity of output demanded tends to decrease.

What are some of the factors that can shift the Aggregate Demand (AD) curve?

Factors that can shift the AD curve include changes in expectations, wealth, the stock of physical capital, and fiscal and monetary policies. For example, an increase in consumer optimism can boost spending, shifting the AD curve to the right.

How does the Short-Run Aggregate Supply (SRAS) curve respond to changes in the aggregate price level?

The SRAS curve shows a positive relationship between the aggregate price level and the quantity of output supplied. As the price level increases, firms are encouraged to produce more due to higher revenue, as wages and other input costs remain sticky in the short run.

What does the Long-Run Aggregate Supply (LRAS) curve represent?

The LRAS curve represents the economy’s potential output level, where all resources are fully employed, and price levels do not affect the output. It is vertical at the potential GDP, indicating that in the long run, the economy produces at its full capacity.

How does the LRAS curve change over time?

Over time, the LRAS curve can shift to the right due to long-term growth factors such as technological advancements, increases in human capital, and improvements in the stock of resources. Conversely, the LRAS curve can shift left if there are factors hampering long-term growth.

What is the concept of the output gap?

The output gap is the difference between actual GDP and potential GDP. A negative output gap occurs during recessions when actual GDP is below potential GDP, and a positive output gap occurs when actual GDP exceeds potential GDP, indicating an overheated economy.

What factors influence short-term fluctuations in real GDP according to the AD-AS model?

Short-term fluctuations in real GDP are influenced by changes in aggregate demand, such as fiscal and monetary policies, and shifts in the SRAS curve due to changes in input prices or supply shocks.

What is the significance of the long-run vertical LRAS curve?

The vertical LRAS curve signifies that in the long run, the economy’s output is determined by the availability and efficiency of resources, not by changes in the aggregate price level. It reflects the economy's potential output.

How do changes in productivity and technology affect the AD-AS model?

Changes in productivity and technology can lead to shifts in both the AD and LRAS curves. Improved productivity and technological advancements can increase potential output, shifting the LRAS curve to the right and potentially increasing aggregate demand as firms expand and invest more.