AP MacroeconomicsThe AS/AD Model

FRQ – 2011 #1; 2011B #1; 2010 #1; 2010B #1; 2009B

#1; 2008B #1; 2007 #1; 2007B #1; 2006 #1; 2006B

#1

The AS/AD Model• The equilibrium of AS & AD

determines current output (GDPR) and the price level (PL)

GDPR

PL

AD

SRASLRAS

YF

P

Full Employment• Full Employment equilibrium exists

where AD intersects SRAS & LRAS at the same point.

GDPR

PL

AD

SRASLRAS

YF

P

Recessionary Gap• A recessionary gap exists when

equilibrium occurs below full employment output.

GDPR

PL

AD

SRASLRAS

YF

P

Y

Inflationary Gap• An inflationary gap exists when

equilibrium occurs beyond full employment output.

GDPR

PL

AD

SRASLRAS

YF

P

Y

Changes (Δ) in AD• Δ Consumption (C)

– C↑ .: AD .: GDPR↑ & PL↑ .: u%↓ & π%↑– C↓ .: AD .: GDPR↓ & PL↓ .: u%↑ & π%↓

• Δ Gross Private Investment (IG)– IG↑ .: AD .: GDPR↑ & PL↑ .: u%↓ & π%↑– IG↓ .: AD .: GDPR↓ & PL↓ .: u%↑ & π%↓

• Δ Government Spending (G) – G↑ .: AD .: GDPR↑ & PL↑ .: u%↓ & π%↑– G↓ .: AD .: GDPR↓ & PL↓ .: u%↑ & π%↓

• Δ Net Exports (XN)– XN↑ .: AD .: GDPR↑ & PL↑ .: u%↓ & π%↑– XN↓ .: AD .: GDPR↓ & PL↓ .: u%↑ & π%↓

Increase in AD

C↑, IG↑, G↑ and/or XN↑ .: AD .: GDPR↑ & PL↑ .: u%↓ & π%↑

GDPR

PL

AD

SRASLRAS

YF

P

Y

AD1

P1

Decrease in AD

C↓, IG↓, G↓ and/or XN↓ .: AD .: GDPR↓ & PL↓ .: u%↑ & π%↓

GDPR

PL

AD

SRAS

LRAS

YF

P

Y

AD1

P1

Changes (Δ) in SRAS• Δ Input Prices

– Input Prices↓ .: SRAS .: GDPR↑ & PL↓ .: u%↓ & π%↓

– Input Prices↑ .: SRAS .: GDPR↓ & PL ↑ .: u%↑ & π%↑

• Δ Productivity– Productivity↑ .: SRAS .: GDPR↑ & PL↓ .: u%↓ & π

%↓

– Productivity↓ .: SRAS .: GDPR↓ & PL ↑ .: u%↑ & π%↑

• Δ Legal-Institutional Environment

– Deregulation .: SRAS .: GDPR↑ & PL↓ .: u%↓ & π%↓

– Regulation .: SRAS .: GDPR↓ & PL ↑ .: u%↑ & π%↑

Increase in SRAS

Input Prices↓, Productivity↑, and/or Deregulation .: SRAS .: GDPR↑ & PL↓ .: u%↓ & π%↓

GDPR

PL

AD

SRASLRAS

YF

P

Y

SRAS1

P1

Decrease in SRAS

Input Prices↑, Productivity↓, and/or Regulation .: SRAS .: GDPR↓ & PL↑ .: u%↑ & π%↑

GDPR

PL

AD

SRAS

LRAS

YF

P

Y1

SRAS1

P1

AS / AD Summary• ΔC, ΔIG, ΔG, and/or ΔXN = Δ AD

– AD .: GDPR↑ & PL↑ .: u%↓ & π%↑

– AD .: GDPR↓ & PL↓ .: u%↑ & π%↓

• Δ Input Prices, Δ Productivity, and/or Δ Regulation = Δ SRAS– SRAS .: GDPR↑ & PL↓ .: u%↓ & π%↓

– SRAS .: GDPR↓ & PL ↑ .: u%↑ & π%↑

• The AS/AD Model is the most important graph in AP Macroeconomics.

• KNOW IT!!!

AD-AS Model Practice Questions

Use an appropriately labeled AD-AS model to illustrate the

impact of each of the following events on price level, output,

and unemployment.

Practice Question #1• Assume the economy is in equilibrium at full full

employmentemployment. If government spending (G) increasesgovernment spending (G) increases due to an outbreak of war, what is the impact of the spending on price level, output, and unemployment?

• What economic condition or problem results?

____ ____

____ Price Level

____ Output

____ UnemploymentProblem:

PriceLevel

Real GDP (GDPR)

SRAS

AD1

PLF

YF

LRAS ADAD

ADAD22

PL2

Y2

Practice Question #2• Assume the economy is in equilibrium at full full employmentemployment. If consumer indebtedness risesconsumer indebtedness rises, what is the impact of the indebtedness on the price

level, output, and unemployment?• What economic condition or problem results?

PriceLevel

Real GDP (GDPR)

SRAS

AD1

PLF

YF

LRAS____ ____

____ Price Level

____ Output

____ UnemploymentProblem:

AD2

PL2

Y2

ADAD

Practice Question #3• Assume the economy is in equilibrium at full full

employmentemployment. If OPEC restricts the supply of oil and raises OPEC restricts the supply of oil and raises energy costs across the economyenergy costs across the economy, what is the impact of the higher production costs on price level, output, and unemployment?

• What economic problem/condition results?

PriceLevel

Real GDP (GDPR)

SRAS1

AD

PLF

YF

LRAS____ ____

____ Price Level

____ Output

____ UnemploymentProblem:

SRAS2

PL2

Y2

ASAS

Practice Question #4• Assume the economy is in a recessionrecession. If

government reduces personal income taxes,government reduces personal income taxes, what is the impact of the tax cut on price level, output, and unemployment?

• What economic condition may result?

PriceLevel

Real GDP (GDPR)

SRASLRAS

AD1

PL1

Y1

____ ____

____ Price Level

____ Output

____ UnemploymentCondition:

YF

ADAD22

PLF

ADAD

Practice Question #5• Assume the economy is overheated and experiencing

serious demand-pull inflation. If the FED increases the FED increases interest rates by reducing the money supply, interest rates by reducing the money supply, what will be the impact of the FED action on the price level, output, and unemployment?

• What problem or condition may result?

PriceLevel

Real GDP (GDPR)

SRASLRAS

AD1

Y1

PL1

____ ____

____ Price Level

____ Output

____ UnemploymentCondition:

ADAD22

PLF

YF

ADAD

Practice Question #6• Assume the economy is in equilibrium at full full

employmentemployment. If productivity increasesproductivity increases due to technological developments, what is the impact of the increased productivity on the price level, output, and unemployment?

PriceLevel

Real GDP (GDPR)

SRAS1

AD

PLF

YF

LRAS____ ____

____ Price Level

____ Output

____ Unemployment

SRASSRAS22

PLPL22

YY22

ASAS