AP Macroeconomics The 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) LRAS SRAS PL P AD YF GDPR

Full Employment Full Employment equilibrium exists where AD intersects SRAS & LRAS at the same point. LRAS SRAS PL P AD YF GDPR

Recessionary Gap A recessionary gap exists when equilibrium occurs below full employment output. SRAS LRAS PL P AD Y YF GDPR

Inflationary Gap An inflationary gap exists when equilibrium occurs beyond full employment output. LRAS SRAS PL P AD YF Y GDPR

Changes (Δ) in AD Δ Consumption (C) Δ Gross Private Investment (IG) 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%↓

C↑, IG↑, G↑ and/or XN↑ .: AD  .: GDPR↑ & PL↑ .: u%↓ & π%↑ Increase in AD SRAS LRAS PL  P1  P AD1 AD  Y YF GDPR C↑, IG↑, G↑ and/or XN↑ .: AD  .: GDPR↑ & PL↑ .: u%↓ & π%↑

C↓, IG↓, G↓ and/or XN↓ .: AD  .: GDPR↓ & PL↓ .: u%↑ & π%↓ Decrease in AD LRAS PL SRAS  P  P1 AD AD1  YF Y GDPR C↓, IG↓, G↓ and/or XN↓ .: AD  .: GDPR↓ & PL↓ .: u%↑ & π%↓

Changes (Δ) in SRAS Δ Input Prices Δ Productivity 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 LRAS PL SRAS1  P  P1 AD  Y YF GDPR Input Prices↓, Productivity↑, and/or Deregulation .: SRAS  .: GDPR↑ & PL↓ .: u%↓ & π%↓

Decrease in SRAS Input Prices↑, Productivity↓, and/or Regulation LRAS PL SRAS  P1  P AD  Y1 YF GDPR Input Prices↑, Productivity↓, and/or Regulation .: SRAS  .: GDPR↓ & PL↑ .: u%↑ & π%↑

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 employment. If government 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 Real GDP (GDPR) SRAS AD1 PLF YF LRAS AD AD2 PL2 Y2 Inflation ____ ____ ____ Price Level ____ Output ____ Unemployment Problem:

What economic condition or problem results? Practice Question #2 Assume the economy is in equilibrium at full employment. If consumer indebtedness rises, what is the impact of the indebtedness on the price level, output, and unemployment? What economic condition or problem results? Price Level Real GDP (GDPR) SRAS AD1 PLF YF LRAS AD2 PL2 Y2 AD Recession ____ ____ ____ Price Level ____ Output ____ Unemployment Problem:

Stagflation Practice Question #3 SRAS2 PL2 Y2 AS Price Level Assume the economy is in equilibrium at full employment. If OPEC restricts the supply of oil and raises energy costs across the economy, what is the impact of the higher production costs on price level, output, and unemployment? What economic problem/condition results? SRAS2 PL2 Y2 AS Stagflation Cost-Push Inflation Price Level Real GDP (GDPR) SRAS1 AD PLF YF LRAS ____ ____ ____ Price Level ____ Output ____ Unemployment Problem:

Practice Question #4 Assume the economy is in a recession. If government reduces personal income taxes, what is the impact of the tax cut on price level, output, and unemployment? What economic condition may result? Price Level Real GDP (GDPR) SRAS LRAS AD1 PL1 Y1 YF AD2 PLF AD Full Employment ____ ____ ____ Price Level ____ Output ____ Unemployment Condition:

Full Employment? Practice Question #5 Price Level Real GDP (GDPR) SRAS Assume the economy is overheated and experiencing serious demand-pull inflation. If the FED increases 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? Price Level Real GDP (GDPR) SRAS LRAS AD1 Y1 PL1 AD2 PLF YF AD Full Employment? ____ ____ ____ Price Level ____ Output ____ Unemployment Condition:

Practice Question #6 Assume the economy is in equilibrium at full employment. If productivity increases due to technological developments, what is the impact of the increased productivity on the price level, output, and unemployment? Price Level Real GDP (GDPR) SRAS1 AD PLF YF LRAS SRAS2 PL2 Y2 AS ____ ____ ____ Price Level ____ Output ____ Unemployment