AS/AD Model Review

AD/AS Model The AS Curve 3 phases: (1) Flat: occurs during recessions. Note: Price Level = Inflation level The AS Curve 3 phases: (1) Flat: occurs during recessions. Unemployment is high, GDP is low Price Level AS1 3 (2) Sloping Section: no recession. Unemployment is relatively low but above the Full Employment level (4%) 2 1 (3) Vertical Section: Economy is growing too fast. Unemployment is below Full Employment (4%) (i.e. there are Too many jobs!) Real GDP Conclusion of AS: The economy has a speed limit. If it grows too fast, you will end up with inflation and no increase in GDP (section 3 of AS curve)

AD/AS Model You draw the AD curve on 1-section of the AS curve based on the economic situation AD1 UNEMPLOYMENT 3% GDP TOO FAST Price Level AS1 AD1 UNEMPLOYMENT 5% GDP MODERATE AD1 RECESSION Real GDP

FISCAL POLICY Fiscal Policy will shift AD curve Economy in recession Price Level AS1 AD2 Expansionary fiscal policy needed AD1 Lower Taxes & ↑ Gov’t spending AD shifts right Real GDP End result: higher GDP, more Jobs & slightly higher inflation