Dynamic AD-AS Model: Inflation and Recession - Video Tutorials & Practice Problems

Dynamic AD-AS Model: Inflation

Alright now let's see how inflation and recessions fit into our dynamic aggregate demand aggregate supply model. So let's start here with inflation. This is a situation where prices are rising, right inflation where prices are rising. So in our dynamic A. D. A. S. Model it occurs when our total spending so the spending being aggregate demand is increasing faster than total production are aggregate supply. Okay. So that's the idea here. And specifically short run aggregate supply when we when we do it in this model. So think about it, there's more spending, people are trying to buy more stuff but the production isn't keeping up so the prices are gonna go up because there's more demand than supply in that case. All right. So let's let's go ahead and draw our initial situation. We would have some sort of standard aggregate demand aggregate supply where we have our long run aggregate supply, our short run aggregate supply and our aggregate demand. Okay. And I'm gonna put a one next to all of these because that's our original situation. We've got our price level on the Y axis and Real GDP on the X axis. Okay, let me get out of the way. So you see everything. So this is our initial situation here and we would have this price level stay right here. Okay. And like we said in the A. D. A. S. Model or the dynamic A. D. A. S. Model, everything's gonna shift to the right year over a year. Now when we first saw this graph, everything shifted equally to have a same price level from one year to the next. However, if everything doesn't shift equally, that's when we have a situation like this where we're gonna have inflation um or possibly a recession. So here we're gonna start with the inflation and this is like I said, where total spending increases faster than total production. So what we're gonna do is we're gonna shift our spending our aggregate demand, we're gonna shift it far to the right, we're gonna do a big shift for the aggregate demand. So that's 82. And remember everything is shifting to the right, our long run aggregate supply can shift to the right as well. But what we're gonna do is we're gonna make the short run aggregate supply only shift a little bit. So long run aggregate supply. Uh number two, But short run aggregate supply will only shift it just a little bit so make it a smaller space in between those. Oh well we still wanted to cross, so let's try and make it there we go. Alright, so there's our short run aggregate supply, number two and now I know there's a lot of curves there, what are we looking for? Well, we just drew three new curves in the new color red, right so the three red, where the three red ones meat, that is our new equilibrium because that's our new short run aggregate supply, our new long run aggregate supply and our new aggregate demand. Okay, so this is our new long run equilibrium, but notice that the price level has gone up and that's because just like I said before that the total spending, we shifted the the aggregate demand curve a lot more than we shifted the short run aggregate supply there. Okay, so GDP still increases year over year, like we would expect with the dynamic model because we have that increase in our potential GDP but we also see the increase in the price levels there. Okay, so the main thing here is one shift shift a. D a lot to shift a short run aggregate supply a little. Okay. And then obviously we're shifting long run aggregate supply uh as well. Now it's not like a lot or a little it's just to that new equilibrium, we're just shifting it to the right. Okay, the big thing that that leads to this price inflation is that aggregate demand shifting more than the short run aggregate supply. Cool. So that's what leads to this higher price level. Let's go ahead and pause and let's talk about recessions in the next video

Dynamic AD-AS Model: Recession

Alright. So now let's talk about recessions in the dynamic A. D. A. S. Model and we'll look at a specific example the 7 4009 recession. And what we're gonna do is we're gonna visualize it on the graph but these are some important things that happened during the recession and we're gonna take those points and turn them into factors on the graph. So the first one was the end of the housing bubble. Whenever we talk about the great recession of 2007 and 2009, we always talk about the housing bubble that cry and what happened is when the housing bubble crashed, it led to only a small increase in aggregate demand. Remember in the dynamic model, we're always shifting to the right, we're shifting everything to the right. However, this crash in the market led to only a small increase. Okay, that factored with our second bullet point here, the financial crisis, this also affected our aggregate demand as well. Because of the crash in the housing market there was an unavailability of credit, there was a financial crisis that went with it. And since there was no credit, there were no loans being made, firms were not making investment, there was no uh no funds available. So aggregate demand shifted to the right even less. Right? So the aggregate demand, what we're gonna see is gonna have a very small increase to the right now. What made matters worse was our third bullet point here, a supply shock coming from increasing oil prices. So international competition mostly from china where there was a lot of production going on, caused oil prices to skyrocket during this period as well. So this this increasing oil prices caused a shift of our short run aggregate supply to the left. If you recall when we talked about supply shocks before, they're not gonna affect our long run aggregate supply, our long run aggregate supply is still going to increase in this model year over year because our potential GDP is still increasing based on um you know, technology increases in the labor force, whatever leads us to have a bigger potential GDP, however, the short run aggregate supply is going to be affected by these increased oil prices, which is more of a temporary situation than our long run situation. Okay, so this supply shock shifted a short run aggregate supply to the left, and it was actually a big shift. So we're gonna say, s ras went down a lot. Okay, so we're still gonna see increases in aggregate demand increases in long run aggregate supply, but we're gonna see a big decrease in our short run aggregate supply, leading to an equilibrium. Um that was quite a mess. We had higher prices and low production, low, low GDP as well. So let's go to our graph here and let's look at it here. So we're gonna have our same graph with our price level and our real GDP, And then we'll have our initial situation, let's say that we started in an equilibrium, which isn't even totally true, but just to make it simple, we'll start in in in in a long run equilibrium here. And this will be, say in 2007, we were at this equilibrium with price level one. Okay, and like I said, okay, let me let me label it first, we got our long run aggregate supply one, short run aggregate supply one, and aggregate demand one. Okay, so that's everything uh we've put on the graph so far and we'll say this was in 2007, so I'll put 2007, actually 2007 And then all of these factors started to occur, there was a crash in the market, the financial crisis, the supply shock, and then we had our shifts for the 2008 curves, so we still see long run aggregate supply, our potential GDP increasing year over year. Okay, so this is our long run aggregate supply in 2008 still increased. However, nothing was able to keep up with it. Our aggregate demand only increased a little bit. We're only going to shift it to the right, just a little bit here. So this is aggregate demand in 2008. It increased just a little bit from 2007 to 2008, but our short run aggregate supply decreased a lot. So what we're gonna do is we're gonna have a short run equilibrium, that's not in our long run equilibrium. let me draw this arrow somewhere else. Let's see, short run. So this short run aggregate supply is shifting to the left and it's shifting quite a bit, so we're gonna shift it quite a bit way over here. So notice how much bigger that shift was in that short run aggregate supply, So it's kind of going through this. Let me let me fix that a little bit. So this was our original long run aggregate supply 2007 and finally our short run aggregate supply In 2008. Okay, so I know we've got a lot of curves there, but what we have is a short run equilibrium, that's not in the long run, right in 2008, where is our short run equilibrium? So our short run equilibrium is gonna be where our aggregate demand and our short run aggregate supply cross, can you find that point? I know we got a lot going on, so where's our aggregate demand for 2008? It's the red aggregate demand and our short run aggregate supply for 2008 is our short run aggregate supply and those meat right here. So notice what's happened from year over year, we had our original GDP in 2007 and our price level in 2007 And now in 2008 the price level had skyrocketed and our GDP had gone down, so it was just like Doubly bad, Everything was bad here, our GDP was down and our price level had gone up. Okay, so the recession um occurred and we saw higher prices and lower GDP year over year. Okay. And that's from this point right here. Okay, so that that was how the 2007, 2009 recession would look like on the dynamic A. D. A. S. Model. Now, I wouldn't expect you to have to draw this out, but it's still good to know when you have to study the dynamic model, uh how how to graph the inflation and recession using that model. Cool. Alright. Let's pause here and let's move on to the next video.