Aggregate supply (AS); Determinants of AS.
- the total amount of goods and services that all industries in the economy will produce at every given price level
AS represents the sum of the supply curves of all the industriesin the economy
The relationship between the price level output businesses offer for sole
is direct or positive.
19. Segments of AS curve.AS curve consists of 3 segments:
1) horizontal (O-Y1)
-Real levels of output are less than the full - employment output
-The economy is in a recession
-the large amounts of unused machinery and unemployed workers are available for production
-workers unemployed for a few months will hardly expect a wage increase
-the price is on the same level
2) Intermediate (up sloping) Y1- Y2
- Real out put rises!
-an expansion of real output is accompanied by a rising price level
per-unit production costs rise and firms must receive higher product prices for their output to be profitable
3) Vertical Y2
-the economy reaches full capacity real OR FULL EMPLOYMENT real output-Individual firms may try to expand production by bidding resources away from other firms Thus bidding will raise resources price (costs) and product prices-
-BUT real output will remain UNCHANGED (is stable)
AS: the Keynesian vs. Classical Debate.
The Classical theory: The fundamental principle of the classical theory is that the economy is self-regulating. Classical economists maintain that the economy is always capable of achieving the natural level of real GDP or output, which is the level of real GDP that is obtained when the economy's resources are fully employed. The classical doctrine—that the economy is always at or near the natural level of real GDP—is based on two firmly held beliefs: Say's Law and the belief that prices, wages, and interest rates are flexible.
The Keynesian theory: Keynes's theory of the determination of equilibrium real GDP, employment, and prices focuses on the relationship between aggregate income and expenditure. Keynes used his income-expenditure model to argue that the economy's equilibrium level of output or real GDP may not correspond to the natural level of real GDP. In the income-expenditure model, the equilibrium level of real GDP is the level of real GDP that is consistent with the current level of aggregate expenditure. If the current level of aggregate expenditure is not sufficient to purchase all of the real GDP supplied, output will be cut back until the level of real GDP is equal to the level of aggregate expenditure. Hence, if the current level of aggregate expenditure is not sufficient to purchase the natural level of real GDP, then the equilibrium level of real GDP will lie somewhere below the natural level.
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21. Equilibrium - classical model. Ratchet effect.Equilibrium – the intersection of the AD and AS curves determines the economy’s equilibrium price level and equilibrium real domestic output.
· 
Beyond full-employment (Y3)
inflation, low unemployment
· Below full-employment (Y1)
negative growth, negative inflation
· At full employment (Y2)
stable prices, low inflation, low unemployment steady,
economic growth
Ratchet effect – is the commonly observed phenomenon that some processes can not go backwards once certain things happened. The producers observe that shifting-down AD leads to changes in equilibrium, but not in the price level. Prices are stable.
22. Consumption and Saving.Consumption savings – DL is the basic determinant of consumption and personal savings. Households can consume more than their incomes by liquidating accumulated wealth or by borrowing – C0.
· 
the 45 degree line represents DI=C, if households were to consumer 100% of their DI at every level of DI.
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