The aggregate demand/aggregate supply (AD/AS) model connects the economy’s output to its potential level and helps explain how growth and unemployment change over time. This lesson focuses on long-run growth, short-run business-cycle fluctuations, and the distinction between cyclical and natural unemployment.
Potential GDP is the level of real output an economy can produce when its resources are employed at sustainable, normal levels. In the AD/AS diagram, it is often represented by a vertical line marking the full-employment level of GDP.
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How does long-run growth appear in the AD/AS model?
Long-run growth is represented by aggregate supply and the potential-GDP line gradually shifting right as productive capacity increases.
What is potential GDP?
Potential GDP is the level of output an economy can produce at sustainable, normal levels of resource use. It is commonly associated with the full-employment level of GDP.
What does a recession look like in an AD/AS diagram?
It is shown when equilibrium real GDP is substantially below potential GDP, with the equilibrium level of output to the left of the potential-GDP line.
What is cyclical unemployment?
Cyclical unemployment is short-run unemployment caused by business-cycle fluctuations. It tends to rise when output falls below potential and decline as output approaches potential.
How does the natural rate of unemployment differ from cyclical unemployment?
The natural rate is the baseline unemployment that persists over time in a healthy economy and reflects labor-market matching and institutions. Cyclical unemployment varies with short-run expansions and contractions.
Quiz questions
How does the AD/AS model represent long-run economic growth?Answer: As a gradual rightward shift in aggregate supply and potential GDP.
In an AD/AS diagram, what indicates that the economy is in a recession?Answer: Equilibrium real GDP is substantially below potential GDP.
When aggregate demand rises while the economy is near potential GDP, what is the likely effect?Answer: The price level rises more strongly than real output.
What typically happens when important input costs rise across many firms?Answer: Short-run aggregate supply shifts left, raising the price level and lowering real output.
Which processes can contribute to persistent inflation?Answer: Repeated demand stimulus and inflation expectations can reinforce continuing price increases.
Based on Principles of Economics 3e by Steven A. Greenlaw, David Shapiro, Daniel MacDonald (OpenStax), licensed CC BY 4.0. Adapted into a summary, flashcards and quizzes.