I presented the model for aggregate supply and Effective demand, the AS-ED model.
What are just a few preliminary general principles that we can takeaway from this model?
Short-run Aggregate Supply Curve
- As unit labor costs rise, businesses need a higher inflation rate in order to keep producing the same amount.
- As unit labor costs decrease, businesses need a lower inflation rate in order to keep producing the same amount.
- As capacity utilization decreases (as in the case of a recession), businesses need a higher inflation rate to keep producing the same amount.
- A rise in potential real GDP (holding all else constant, even real output) will indicate a lower inflation rate.
(note: These principles for the Aggregate supply curve apply when it is sloping up and to the right.)
Effective Demand Curve
- As unit labor costs rise, people would accept a higher inflation rate to be able to demand the same amount.
- As unit labor costs decrease, people would accept a lower inflation rate to be able to demand the same amount.
- As capacity utilization decreases (as in the case of a recession), people would accept a higher inflation rate to be able to demand the same amount.
- As unemployment increases (as in the case of a recession), people would accept a higher inflation rate to be able to demand the same amount.
- As unemployment decreases, people would accept less inflation to demand the same amount.
Crossing Point of SRAS (aggregate supply) & Effective Demand
- The crossing point of the SRAS and ED curves marks the Natural level of real GDP, the LRAS curve.
- As capacity utilization changes, the Natural level of real GDP does not change.
- As unit labor costs change, the Natural level of real GDP does not change.
- As potential real GDP rises, the Natural level of real GDP increases.
- As unemployment increases (as in a recession), the Natural level of real GDP decreases (holding all else constant).
- As unemployment decreases, the Natural level of real GDP increases (holding all else constant).
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