key term - Equilibrium AD-AS Model

Definition

The Equilibrium AD-AS Model represents the point where the aggregate demand (AD) curve intersects with the aggregate supply (AS) curve in an economy, determining the overall price level and output. At this equilibrium point, the quantity of goods and services demanded equals the quantity supplied, leading to stable economic conditions. Changes in factors such as consumer confidence, government spending, and production costs can shift these curves, affecting equilibrium.

5 Must Know Facts For Your Next Test

1. The equilibrium level of output occurs when the aggregate demand curve intersects with the short-run aggregate supply curve, determining both the output level and price level in the economy.
2. If aggregate demand increases, it can lead to a higher equilibrium price level and output, while a decrease in aggregate demand can result in lower prices and reduced output.
3. Shifts in the aggregate supply curve can be caused by changes in resource prices, technological advancements, or government policies, which can also impact the equilibrium point.
4. In the long run, economies tend to move toward full employment equilibrium, where all resources are utilized efficiently, but short-run fluctuations can cause deviations from this point.
5. Equilibrium can also be affected by external shocks such as natural disasters or geopolitical events, leading to rapid changes in both aggregate demand and supply.

Review Questions

• How do changes in aggregate demand and aggregate supply affect the equilibrium price level and output in an economy?
  • Changes in aggregate demand or aggregate supply directly impact the intersection point of the two curves on the AD-AS model. For instance, an increase in aggregate demand shifts the AD curve rightward, leading to a higher equilibrium price level and increased output. Conversely, a leftward shift in aggregate supply due to rising production costs would raise prices while reducing output at equilibrium.
• Discuss how external shocks might influence the equilibrium in the AD-AS model.
  • External shocks such as natural disasters or sudden geopolitical tensions can lead to immediate shifts in either aggregate demand or aggregate supply. For example, a natural disaster may disrupt production capacity, shifting the AS curve leftward and increasing prices while reducing output. This can create economic instability as businesses and consumers adjust to new conditions, influencing long-term economic growth and recovery strategies.
• Evaluate the implications of achieving long-run versus short-run equilibrium in the AD-AS model on economic policy decisions.
  • Achieving long-run equilibrium is essential for sustainable economic growth, as it indicates that resources are being used efficiently at full employment. However, when only short-run equilibrium is achieved due to temporary shifts in demand or supply, policymakers must consider measures such as fiscal or monetary interventions to stabilize the economy. An understanding of these distinctions helps guide effective policy decisions aimed at promoting stability and growth over time.

Related terms

Aggregate Demand (AD): The total demand for goods and services within an economy at a given overall price level and in a given time period.

Aggregate Supply (AS):

The total supply of goods and services that firms in an economy plan to sell at a given overall price level in a given time period.

Demand-Pull Inflation: A type of inflation that occurs when aggregate demand in an economy outpaces aggregate supply, often due to increased consumer spending or government expenditure.