Topic 6: AS-AD Model - Knowledge Summary and Exam Analysis

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University of Toronto Scarborough
Economics for Management Studies
Iris Au

Knowledge Summary: Topic 6: Part A – The AS-AD Model (continued) Aggregate Supply (AS) • Aggregate supply (AS) curve represents the amount of output that firms in the economy are willing to produce at each price level • The slope of AS curve depends on employment levels: 1. If there is a lot of unemployment (Y* < Y ), we expect that firms will be willing to supply FE more even if price does not increase much since firms find it easy to hire workers if they want to expand  AS curve will be relatively flat (i.e. elastic) 2. If there is not much unemployment (Y*> Y ), FE expect that firms will be hard-pressed to supply more even if price increases since firms may find it difficult to hire additional workers or to have them work overtime  AS curve will be relatively steep (i.e. inelastic) Note: • Sometimes we simplify the AS curve so that in the long run, the AS curve is vertical; in the short run, AS curve is horizontal • In MGEA06, we assume AS curve is upward sloping – firms are willing to produce more when price rises Putting AS & AD Together • AD is derived from setting AE to Y at different price levels • For the AS curve, there is a positive relationship between prices and the amount of output produced by firms • Equilibrium is given by the intersection of AS and AD Adjustment Process of AS-AD Model • Case 1: If initial P < P* => excess demand => pressure for price to go up => price returns to equilibrium level • Case 2: If initial P > P* => excess supply => pressure for price to drop => price returns to equilibrium level Topic 6: Part B – Effects of a Change in AE in the AS-AD Model
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