Projekt :
„Odpowiedź na wyzwania gospodarki opartej na
wiedzy: nowy program nauczania na WSHiP”.
Projekt współfinansowany ze środków Unii
Europejskiej w ramach Europejskiego Funduszu
Społecznego.
Aggregate Supply –
Aggregate Demand
Model
MEDIUM RUN ANALYSIS
To derive AS relation, we
need:
WS equation:
W  P f u , z 
e
PS equation:
P  1   W
To derive AS relation, we
need:
Unemployment rate:
u
U

L
LN
L
1
N
1
L
Y
L
Assumption about a production function:
Y  AN
Where A=1 and therefore Y=N
Finally we receive:

AS relation:
Y


P  P 1    f  1 
, z
L


e
that shows a relation between current price level and expected price
level and level of output.
The Aggregate Supply curve (which probably could
have a better name like for example ”labour market
curve” )is illustrating this relation. It is an upward sloping
curve, which shows a positive correlation between
output and price level.
To derive AD relation, we
need:

A basic knowledge of IS-LM model, how
equilibrium in the goods and money market is
defined there:
IS :
LM :
Y  C Y  T
M
P
  I Y , i   G
 Y L i 
Finally we receive:
   
M
Y Y
, G, T
 P





AD relation says that output is an increasing function of the
real money stock and government spending and a
decreasing function with respect to taxes.
The Aggregate Demand curve is a downward sloping
curve that shows a negative correlation between output
and price level.
INTERSECTION OF AS & AD
CURVES IS…
A newly defined equilibrium of the whole
economy in the medium run while
equilibrium in all three markets (labour, goods
and money one) is considered.
A new approach towards
equilibrium:
AS-AD model allows us to observe the
adjustment of output over time.
If Y≠Yn, say output exceeds the natural level
of output (see figure 7-6), then:
the price level is higher than the expected
price level.
WHAT WILL HAPPEN?
The mechanism:
1. The wage setters will modify their expectations, they will increase
the expected price level (AS shifts up).
2. Wage setters will set their wage higher due to the modified
expectations [W=f(Pe)], therefore under the wage setters
pressure the price setters will increase the price level [P=f(W)].
3. The higher price level leads to a lower real money stock.
4. A lower real money stock leads to a higher interest rate
(remember about IS-LM model).
5. A higher interest rate leads to lower demand for good
Summing it up:
If output is above the natural level
of output, the AS curve shifts up
over time, until output has
decreased back to the natural
level of output.
Let’s check what are the policy
effects in the medium run
We will examine two
cases:
1. Monetary expansion
2. A decrease in the
budget defficit
MONETARY EXPANSION
1. Y=Yn, If there is an increase of nominal money, the
AD curve shifts to the right.
2. In a new intersection point of AD and AS output is
higher than natural level of output, that will cause
revision of price expectations – now the current
price level is higher than expected one.
3. Revision of the expectations (the wage setters
push the wages, the price setters increase the
prices) can be illustrated by a shift of the AS to the
left.
The effects of monetary
expansion in the medium run:
The increase in nominal money is offset by a
proportional increase in the price level. The real
money is unchanged, therefore, output is back to
its initial value Yn
It looks like it is the road to NOWHERE, although…
In the medium run expansionary monetary policy can help the
economy to move out of recession and return faster to the natural
level of output!
The effects of monetary expansion in
the medium run
Summary:
output level
– unchanged
interest rate
– unchanged
price level
- increase
A deficit reduction in the
medium run
1. There is a decrease in G, while T is
unchanged, the AD curve shifts to the left.
2. Output is below the natural level of output. Both
the interest rate (the prices go down, the real money
stock goes up and the interest rate goes down - see
IS-LM model)and the output are lower .
3. The price level goes down (AS shifts to
the right due to the price expectations
revision)
In the medium run, output returns to its
natural level
A deficit reduction in the medium run
Summary:
output level
– unchanged
interest rate
– decrease
price level
- decrease
What about the changes in the
price of oil?
1.
2.
3.
4.
An increase in the price of oil leads to lower real
wage and higher natural rate of unemployment
(see WS-PS relations).
An increase of markup results from an increase in
the price level and this shifts AS to the left
There is a new level of natural output given (as
there is a new natural unemployment rate)
Output has decreased and natural level of output
has decreased even more, therefore Y is still
above the Yn, then the AS continues to shift up.
The changes in the price of oil
Summary:
output level
– decrease
interest rate
– increase
price level
- increase
Projekt :
„Odpowiedź na wyzwania gospodarki opartej na
wiedzy: nowy program nauczania na WSHiP”.
Projekt współfinansowany ze środków Unii
Europejskiej w ramach Europejskiego Funduszu
Społecznego.