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Mechanics of AD-AS
AD
AD
AD’
Y
AD’
AD
AD
AD
SRAS’
AD
AD’
Y
AD’
AD
AD
AD
AD
AD’
Y
Since the shock causes GDP to decrease, the government
increases AD
This returns AD to its original position, and restores the
economy to its original equilibrium
Therefore, the effect of government intervention is to
shorten the recession
Temporary Increase in Demand
LRAS
P SRAS
AD’
AD
Y
Since the shock causes GDP to increase, the government
decreases AD
This returns AD to its original position, and restores the
economy to its original equilibrium
Therefore, the effect of government intervention is to
shorten the boom
Temporary Decrease in Supply
SRAS’
LRAS
P LRAS’
SRAS
Since the
shock causes
GDP to
decrease, the
government
AD’
increases AD
AD
Y
Now the economy is at a new equilibrium with the original
GDP and higher prices. This is a long run equilibrium,
because as the supply shock subsides, LRAS returns to its
original position.
Therefore, the effect of government intervention is to
shorten the recession, but permanently increase prices
Temporary Increase in Supply
LRAS LRAS’
P AD SRAS
Since the
SRAS’ shock causes
GDP to
AD’ increase, the
government
decreases AD
Y
Now the economy is at a new equilibrium with the original
GDP and lower prices. This is a long run equilibrium,
because as the supply shock subsides, LRAS returns to its
original position.
Therefore, the effect of government intervention is to
shorten the boom, but permanently decrease prices
Phillips Curve
LRAS LR Phillips Curve
P SRAS i
SR
Phillips Curve
AD
Y u
AD’
AD SR
Phillips Curve
Y u
SRAS’
SR
Phillips Curve
SR
Phillips Curve’
AD
Y u