- Macroeconomic equilibrium
- Macroeconomic equilibrium is the level of real GDP and the price level at which the aggregate demand and aggregate supply curves intersect.
- Potential output
- Potential output is the amount of real GDP an economy can produce by fully employing its existing labour, physical capital and technology.
Assumptions of the AD/AS model
Can you name three assumptions the AD/AS model rests on?
The model is a simplification, and three assumptions hold it together.
The vertical axis is the price level, an index of all prices, and the horizontal axis is real GDP, the total of all final output.
Can you think of an example?
A rise in the price level from 100 to 102 means prices across the economy are 2 per cent higher, not that one good got dearer.
Along the short-run aggregate supply curve, the prices of inputs such as wages and energy are held constant.
Can you think of an example?
When the price level rises and wages have not yet caught up, each sale is more profitable, so firms produce more along SRAS.
Each curve is drawn holding every other influence constant, so a change in any of those influences shifts the curve.
Can you think of an example?
A rise in consumer confidence is not a price-level change, so it does not move the economy along AD; it shifts the whole AD curve.