{"id":438,"date":"2015-05-05T03:53:38","date_gmt":"2015-05-05T03:53:38","guid":{"rendered":"https:\/\/courses.candelalearning.com\/masterymacro1xngcxmaster\/?post_type=chapter&p=438"},"modified":"2016-07-11T19:38:19","modified_gmt":"2016-07-11T19:38:19","slug":"growth-and-recession-in-the-as-ad-diagram","status":"publish","type":"chapter","link":"https:\/\/courses.lumenlearning.com\/suny-hccc-macroeconomics\/chapter\/growth-and-recession-in-the-as-ad-diagram\/","title":{"raw":"Reading: Growth and Recession in the AS\u2013AD Diagram","rendered":"Reading: Growth and Recession in the AS\u2013AD Diagram"},"content":{"raw":"

Growth and Recession in the AS\u2013AD Diagram<\/h2>\r\nIn the AS\u2013AD diagram, long-run economic growth due to productivity increases over time will be represented by a gradual shift to the right of aggregate supply. The vertical line representing potential GDP (or the \u201cfull employment level of GDP\u201d) will gradually shift to the right over time as well. A pattern of economic growth over three years, with the AS curve shifting slightly out to the right each year, was shown earlier in Figure\u00a010.7 (a).\r\n\r\n[caption id=\"attachment_4506\" align=\"aligncenter\" width=\"780\"]\"The<\/a> Figure 10.7. <\/strong>Shifts in Aggregate Supply (a) The rise in productivity causes the AS curve to shift to the right. The original equilibrium E0 is at the intersection of AD and AS0. When AS shifts right, then the new equilibrium E1 is at the intersection of AD and AS1, and then yet another equilibrium, E2, is at the intersection of AD and AS2. Shifts in AS to the right, lead to a greater level of output and to downward pressure on the price level. (b) A higher price for inputs means that at any given price level for outputs, a lower quantity will be produced so aggregate supply will shift to the left from AS0 to AS1. The new equilibrium, E1, has a reduced quantity of output and a higher price level than the original equilibrium (E0).[\/caption]\r\n\r\nHowever, the factors that determine the speed of this long-term economic growth rate\u2014like investment in physical and human capital, technology, and whether an economy can take advantage of catch-up growth\u2014do not appear directly in the AS\u2013AD diagram. In the short run, GDP falls and rises in every economy, as the economy dips into recession or expands out of recession. Recessions are illustrated in the AS\u2013AD diagram when the equilibrium level of real GDP is substantially below potential GDP, as occurred at the equilibrium point E0<\/sub> in Figure\u00a010.9. On the other hand, in years of resurgent economic growth the equilibrium will typically be close to potential GDP, as shown at equilibrium point E1<\/sub> in that earlier figure.\r\n\r\n[caption id=\"attachment_4508\" align=\"aligncenter\" width=\"780\"]\"The<\/a> Figure 10.8.<\/strong> Shifts in Aggregate Demand (a) An increase in consumer confidence or business confidence can shift AD to the right, from AD0 to AD1. When AD shifts to the right, the new equilibrium (E1) will have a higher quantity of output and also a higher price level compared with the original equilibrium (E0). In this example, the new equilibrium (E1) is also closer to potential GDP. An increase in government spending or a cut in taxes that leads to a rise in consumer spending can also shift AD to the right. (b) A decrease in consumer confidence or business confidence can shift AD to the left, from AD0 to AD1. When AD shifts to the left, the new equilibrium (E1) will have a lower quantity of output and also a lower price level compared with the original equilibrium (E0). In this example, the new equilibrium (E1) is also farther below potential GDP. A decrease in government spending or higher taxes that leads to a fall in consumer spending can also shift AD to the left.[\/caption]\r\n\r\n
\r\n
\r\n

Unemployment in the AS\u2013AD Diagram<\/span><\/h2>\r\nTwo types of unemployment were described in the Unemployment chapter. Cyclical unemployment<\/em><\/a>bounces up and down according to the short-run movements of GDP. Over the long run, in the United States, the unemployment rate typically hovers around 5% (give or take one percentage point or so), when the economy is healthy. In many of the national economies across Europe, the rate of unemployment in recent decades has only dropped to about 10% or a bit lower, even in good economic years. This baseline level of unemployment that occurs year-in and year-out is called the\u00a0natural rate of unemployment<\/em><\/a> and is determined by how well the structures of market and government institutions in the economy lead to a matching of workers and employers in the labor market. Potential GDP can imply different unemployment rates in different economies, depending on the natural rate of unemployment for that economy. In the AS\u2013AD diagram, cyclical unemployment is shown by how close the economy is to the potential or full employment level of GDP. Returning to Figure\u00a010.9, relatively low cyclical unemployment for an economy occurs when the level of output is close to potential GDP, as in the equilibrium point E1<\/sub>. Conversely, high cyclical unemployment arises when the output is substantially to the left of potential GDP on the AS\u2013AD diagram, as at the equilibrium point E0<\/sub>. The factors that determine the natural rate of unemployment are not shown separately in the AS\u2013AD model, although they are implicitly part of what determines potential GDP or full employment GDP in a given economy.\r\n
\r\n

LINK IT UP<\/h3>\r\nWhat is the level of consumer confidence today? Visit this website<\/a> for quick look at current data on consumer confidence.\r\n\r\n<\/div>\r\n

Inflationary Pressures in the AS\u2013AD Diagram<\/span><\/h2>\r\nInflation fluctuates in the short run. Higher inflation rates have typically occurred either during or just after economic booms: for example, the biggest spurts of inflation in the U.S. economy during the twentieth century followed the wartime booms of World War I and World War II. Conversely, rates of inflation decline during recessions. As an extreme example, inflation actually became negative\u2014a situation called \u201cdeflation\u201d\u2014during the Great Depression. Even during the relatively short recession of 1991\u20131992, the rate of inflation declined from 5.4% in 1990 to 3.0% in 1992. During the relatively short recession of 2001, the rate of inflation declined from 3.4% in 2000 to 1.6% in 2002. During the deep recession of 2007\u20132009, the rate of inflation declined from 3.8% in 2008 to \u20130.4% in 2009. Some countries have experienced bouts of high inflation that lasted for years. In the U.S. economy since the mid\u20131980s, inflation does not seem to have had any long-term trend to be substantially higher or lower; instead, it has stayed in the range of 1\u20135% annually.\r\n\r\nThe AS\u2013AD framework implies two ways that inflationary pressures may arise. One possible trigger is if aggregate demand continues to shift to the right when the economy is already at or near potential GDP and full employment, thus pushing the macroeconomic equilibrium into the steep portion of the AS curve. In Figure\u00a010.10 (a), there is a shift of aggregate demand to the right; the new equilibrium E1<\/sub> is clearly at a higher price level than the original equilibrium E0<\/sub>. In this situation, the aggregate demand in the economy has soared so high that firms in the economy are not capable of producing additional goods, because labor and physical capital are fully employed, and so additional increases in aggregate demand can only result in a rise in the price level.\r\n\r\n[caption id=\"attachment_4511\" align=\"aligncenter\" width=\"780\"]\"The<\/a> Figure 10.10. <\/strong>Sources of Inflationary Pressure in the AS\u2013AD Model (a) A shift in aggregate demand, from AD0 to AD1, when it happens in the area of the AS curve that is near potential GDP, will lead to a higher price level and to pressure for a higher price level and inflation. The new equilibrium (E1) is at a higher price level (P1) than the original equilibrium. (b) A shift in aggregate supply, from AS0 to AS1, will lead to a lower real GDP and to pressure for a higher price level and inflation. The new equilibrium (E1) is at a higher price level (P1), while the original equilibrium (E0) is at the lower price level (P0).[\/caption]\r\n\r\n \r\n\r\nAn alternative source of inflationary pressures can occur due to a rise in input prices that affects many or most firms across the economy\u2014perhaps an important input to production like oil or labor\u2014and causes the aggregate supply curve to shift back to the left. In Figure\u00a010.10 (b), the shift of the AS curve to the left also increases the price level from P0<\/sub> at the original equilibrium (E0<\/sub>) to a higher price level of P1<\/sub> at the new equilibrium (E1<\/sub>). In effect, the rise in input prices ends up, after the final output is produced and sold, being passed along in the form of a higher price level for outputs. The AS\u2013AD diagram shows only a one-time shift in the price level. It does not address the question of what would cause inflation either to vanish after a year, or to sustain itself for several years. There are two explanations for why inflation may persist over time. One way that continual inflationary price increases can occur is if the government continually attempts to stimulate aggregate demand in a way that keeps pushing the AD curve when it is already in the steep portion of the AS curve. A second possibility is that, if inflation has been occurring for several years, a certain level of inflation may come to be expected. For example, if consumers, workers, and businesses all expect prices and wages to rise by a certain amount, then these expected rises in the price level can become built into the annual increases of prices, wages, and interest rates of the economy. These two reasons are interrelated, because if a government fosters a macroeconomic environment with inflationary pressures, then people will grow to expect inflation. However, the AS\u2013AD diagram does not show these patterns of ongoing or expected inflation in a direct way.\r\n
\r\n

LINK IT UP<\/h3>\r\nVisit this website<\/a> for current data on business confidence.\r\n\r\n<\/div>\r\n

Importance of the Aggregate Supply\u2013Aggregate Demand Model<\/h2>\r\nMacroeconomics takes an overall view of the economy, which means that it needs to juggle many different concepts. For example, start with the three macroeconomic goals of growth, low inflation, and low unemployment. Aggregate demand has four elements: consumption, investment, government spending, and exports less imports. Aggregate supply reveals how businesses throughout the economy will react to a higher price level for outputs. Finally, a wide array of economic events and policy decisions can affect aggregate demand and aggregate supply, including government tax and spending decisions; consumer and business confidence; changes in prices of key inputs like oil; and technology that brings higher levels of productivity. The aggregate supply\u2013aggregate demand model is one of the fundamental diagrams in this text\u00a0because it provides an overall framework for bringing these factors together in one diagram. Indeed, some version of the AS\u2013AD model will appear in every module\u00a0in the rest of this text.\r\n\r\n<\/div>\r\n<\/div>","rendered":"

Growth and Recession in the AS\u2013AD Diagram<\/h2>\n

In the AS\u2013AD diagram, long-run economic growth due to productivity increases over time will be represented by a gradual shift to the right of aggregate supply. The vertical line representing potential GDP (or the \u201cfull employment level of GDP\u201d) will gradually shift to the right over time as well. A pattern of economic growth over three years, with the AS curve shifting slightly out to the right each year, was shown earlier in Figure\u00a010.7 (a).<\/p>\n

\"The<\/a><\/p>\n

Figure 10.7. <\/strong>Shifts in Aggregate Supply (a) The rise in productivity causes the AS curve to shift to the right. The original equilibrium E0 is at the intersection of AD and AS0. When AS shifts right, then the new equilibrium E1 is at the intersection of AD and AS1, and then yet another equilibrium, E2, is at the intersection of AD and AS2. Shifts in AS to the right, lead to a greater level of output and to downward pressure on the price level. (b) A higher price for inputs means that at any given price level for outputs, a lower quantity will be produced so aggregate supply will shift to the left from AS0 to AS1. The new equilibrium, E1, has a reduced quantity of output and a higher price level than the original equilibrium (E0).<\/p>\n<\/div>\n

However, the factors that determine the speed of this long-term economic growth rate\u2014like investment in physical and human capital, technology, and whether an economy can take advantage of catch-up growth\u2014do not appear directly in the AS\u2013AD diagram. In the short run, GDP falls and rises in every economy, as the economy dips into recession or expands out of recession. Recessions are illustrated in the AS\u2013AD diagram when the equilibrium level of real GDP is substantially below potential GDP, as occurred at the equilibrium point E0<\/sub> in Figure\u00a010.9. On the other hand, in years of resurgent economic growth the equilibrium will typically be close to potential GDP, as shown at equilibrium point E1<\/sub> in that earlier figure.<\/p>\n

\"The<\/a><\/p>\n

Figure 10.8.<\/strong> Shifts in Aggregate Demand (a) An increase in consumer confidence or business confidence can shift AD to the right, from AD0 to AD1. When AD shifts to the right, the new equilibrium (E1) will have a higher quantity of output and also a higher price level compared with the original equilibrium (E0). In this example, the new equilibrium (E1) is also closer to potential GDP. An increase in government spending or a cut in taxes that leads to a rise in consumer spending can also shift AD to the right. (b) A decrease in consumer confidence or business confidence can shift AD to the left, from AD0 to AD1. When AD shifts to the left, the new equilibrium (E1) will have a lower quantity of output and also a lower price level compared with the original equilibrium (E0). In this example, the new equilibrium (E1) is also farther below potential GDP. A decrease in government spending or higher taxes that leads to a fall in consumer spending can also shift AD to the left.<\/p>\n<\/div>\n

\n
\n

Unemployment in the AS\u2013AD Diagram<\/span><\/h2>\n

Two types of unemployment were described in the Unemployment chapter. Cyclical unemployment<\/em><\/a>bounces up and down according to the short-run movements of GDP. Over the long run, in the United States, the unemployment rate typically hovers around 5% (give or take one percentage point or so), when the economy is healthy. In many of the national economies across Europe, the rate of unemployment in recent decades has only dropped to about 10% or a bit lower, even in good economic years. This baseline level of unemployment that occurs year-in and year-out is called the\u00a0natural rate of unemployment<\/em><\/a> and is determined by how well the structures of market and government institutions in the economy lead to a matching of workers and employers in the labor market. Potential GDP can imply different unemployment rates in different economies, depending on the natural rate of unemployment for that economy. In the AS\u2013AD diagram, cyclical unemployment is shown by how close the economy is to the potential or full employment level of GDP. Returning to Figure\u00a010.9, relatively low cyclical unemployment for an economy occurs when the level of output is close to potential GDP, as in the equilibrium point E1<\/sub>. Conversely, high cyclical unemployment arises when the output is substantially to the left of potential GDP on the AS\u2013AD diagram, as at the equilibrium point E0<\/sub>. The factors that determine the natural rate of unemployment are not shown separately in the AS\u2013AD model, although they are implicitly part of what determines potential GDP or full employment GDP in a given economy.<\/p>\n

\n

LINK IT UP<\/h3>\n

What is the level of consumer confidence today? Visit this website<\/a> for quick look at current data on consumer confidence.<\/p>\n<\/div>\n

Inflationary Pressures in the AS\u2013AD Diagram<\/span><\/h2>\n

Inflation fluctuates in the short run. Higher inflation rates have typically occurred either during or just after economic booms: for example, the biggest spurts of inflation in the U.S. economy during the twentieth century followed the wartime booms of World War I and World War II. Conversely, rates of inflation decline during recessions. As an extreme example, inflation actually became negative\u2014a situation called \u201cdeflation\u201d\u2014during the Great Depression. Even during the relatively short recession of 1991\u20131992, the rate of inflation declined from 5.4% in 1990 to 3.0% in 1992. During the relatively short recession of 2001, the rate of inflation declined from 3.4% in 2000 to 1.6% in 2002. During the deep recession of 2007\u20132009, the rate of inflation declined from 3.8% in 2008 to \u20130.4% in 2009. Some countries have experienced bouts of high inflation that lasted for years. In the U.S. economy since the mid\u20131980s, inflation does not seem to have had any long-term trend to be substantially higher or lower; instead, it has stayed in the range of 1\u20135% annually.<\/p>\n

The AS\u2013AD framework implies two ways that inflationary pressures may arise. One possible trigger is if aggregate demand continues to shift to the right when the economy is already at or near potential GDP and full employment, thus pushing the macroeconomic equilibrium into the steep portion of the AS curve. In Figure\u00a010.10 (a), there is a shift of aggregate demand to the right; the new equilibrium E1<\/sub> is clearly at a higher price level than the original equilibrium E0<\/sub>. In this situation, the aggregate demand in the economy has soared so high that firms in the economy are not capable of producing additional goods, because labor and physical capital are fully employed, and so additional increases in aggregate demand can only result in a rise in the price level.<\/p>\n

\"The<\/a><\/p>\n

Figure 10.10. <\/strong>Sources of Inflationary Pressure in the AS\u2013AD Model (a) A shift in aggregate demand, from AD0 to AD1, when it happens in the area of the AS curve that is near potential GDP, will lead to a higher price level and to pressure for a higher price level and inflation. The new equilibrium (E1) is at a higher price level (P1) than the original equilibrium. (b) A shift in aggregate supply, from AS0 to AS1, will lead to a lower real GDP and to pressure for a higher price level and inflation. The new equilibrium (E1) is at a higher price level (P1), while the original equilibrium (E0) is at the lower price level (P0).<\/p>\n<\/div>\n

 <\/p>\n

An alternative source of inflationary pressures can occur due to a rise in input prices that affects many or most firms across the economy\u2014perhaps an important input to production like oil or labor\u2014and causes the aggregate supply curve to shift back to the left. In Figure\u00a010.10 (b), the shift of the AS curve to the left also increases the price level from P0<\/sub> at the original equilibrium (E0<\/sub>) to a higher price level of P1<\/sub> at the new equilibrium (E1<\/sub>). In effect, the rise in input prices ends up, after the final output is produced and sold, being passed along in the form of a higher price level for outputs. The AS\u2013AD diagram shows only a one-time shift in the price level. It does not address the question of what would cause inflation either to vanish after a year, or to sustain itself for several years. There are two explanations for why inflation may persist over time. One way that continual inflationary price increases can occur is if the government continually attempts to stimulate aggregate demand in a way that keeps pushing the AD curve when it is already in the steep portion of the AS curve. A second possibility is that, if inflation has been occurring for several years, a certain level of inflation may come to be expected. For example, if consumers, workers, and businesses all expect prices and wages to rise by a certain amount, then these expected rises in the price level can become built into the annual increases of prices, wages, and interest rates of the economy. These two reasons are interrelated, because if a government fosters a macroeconomic environment with inflationary pressures, then people will grow to expect inflation. However, the AS\u2013AD diagram does not show these patterns of ongoing or expected inflation in a direct way.<\/p>\n

\n

LINK IT UP<\/h3>\n

Visit this website<\/a> for current data on business confidence.<\/p>\n<\/div>\n

Importance of the Aggregate Supply\u2013Aggregate Demand Model<\/h2>\n

Macroeconomics takes an overall view of the economy, which means that it needs to juggle many different concepts. For example, start with the three macroeconomic goals of growth, low inflation, and low unemployment. Aggregate demand has four elements: consumption, investment, government spending, and exports less imports. Aggregate supply reveals how businesses throughout the economy will react to a higher price level for outputs. Finally, a wide array of economic events and policy decisions can affect aggregate demand and aggregate supply, including government tax and spending decisions; consumer and business confidence; changes in prices of key inputs like oil; and technology that brings higher levels of productivity. The aggregate supply\u2013aggregate demand model is one of the fundamental diagrams in this text\u00a0because it provides an overall framework for bringing these factors together in one diagram. Indeed, some version of the AS\u2013AD model will appear in every module\u00a0in the rest of this text.<\/p>\n<\/div>\n<\/div>\n\n\t\t\t

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Candela Citations<\/h3>\n\t\t\t\t\t
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CC licensed content, Shared previously<\/div>