Introduction to Economic Fluctuation; AS-AD

Framework

March 12, 2024

Introduction to Economic Fluctuation; AS-AD Framework March 12, 2024 1/5

Aggregate Demand

Relationship between the quantity of output demanded and the

aggregate price level.
For a fixed value of V , the money supply M determines the nominal
value of output PY , i.e., the dollar (or any currency) value of all
transactions in the economy. If ↑ P, each transaction requires more
currency, so the number of transactions and the number of goods and
services purchased must fall.
A higher Y requires higher M
P . If M is fixed by the central bank, the
higher M
P is accompanied by a lower value of P, and vice-versa.
How does a change in the money supply cause a shift in the AD?

Introduction to Economic Fluctuation; AS-AD Framework March 12, 2024 2/5

Aggregate Supply

Relationship between the quantity of output supplied and the

aggregate price level.
LRAS: Output is fixed. Price level is super flexible, but no change in Y .
SRAS: Price is sticky. Output is super flexible, while there is no change
in price.
How can we shift the equilibrium from the short run to the long run?

Introduction to Economic Fluctuation; AS-AD Framework March 12, 2024 3/5

Stabilization Policy

Shock to the AD
Shock to the AS

Introduction to Economic Fluctuation; AS-AD Framework March 12, 2024 4/5

Practice Set

1. Suppose the Bangladesh Bank reduces the money supply by 5%.

Assume that the velocity of money is constant.
What will happen to the AD curve?
What will happen to the level of output and price-level in the short run
and in the long run? Give a precise numerical example.
2. Suppose that in secario A the CB cares only about keeping the price
level stable and in scenario B, the CB cares only about keeping output
and employment at their natural levels. Explain the following scenario:
A. An exogenous decrease in the velocity of money
B. An exogenous increase in the price of oil.

Introduction to Economic Fluctuation; AS-AD Framework March 12, 2024 5/5