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AD/AS curve help.

On the AD/AS curve, the Y-axis is "General Price Level". Does that just mean rate of inflation? or does it literally mean prices. If it just means prices, why don't we have 0% inflation when the economy is in recession (the flat part of the AS where lots of spare capacity so no inflation caused.

Also why is there no way to experience deflation on this graph?

For the x-axis, its labelled National income, is this a nominal or real value of income?

Thanks in advance

Reply 1

MagicNMedicine

Vertical axis is price level, not inflation.
Horizontal axis is nominal value of income.

The ASAD is a model that assumes perfectly functioning markets and so when you get a reduction in demand and AD shifts in, as well as a fall in output you will get prices adjusting downwards, but in reality you don't get perfectly functioning markets, this is one of Keynes' main points, prices are 'sticky downwards', they adjust upwards much better than they adjust downwards. But you do tend to find that in recessions inflation falls rapidly and you can get deflation.

Reply 2

dslc

Original post by Miryo

is this a nominal or real value of income?

Original post by MagicNMedicine

Horizontal axis is nominal value of income.

I see Real National Income used far more frequently.

Reply 3

MagicNMedicine

Yes I think you are right, it will be real GDP not nominal.

Reply 4

JonathanM

Inflation is a rise in the general level of prices of goods and services in an economy over a period of time.

If you do maths Inflation = ΔPrice/ΔTime
Δ = change
Expansionary fiscal policy and expansionary monetary policy cause an increase in AD. Deflationary versions of these two policies cause a fall.
Supply side policies influence aggregate supply (So does the availability of resources such as oil) .

An increase in AD or a fall in AS causes an increase in Price level, fall in AS causes a fall in real output, rise in AD causes a rise in real output. An increase in price level results in increased price obviously.This "results" in inflation. Inflation exists if price level increases. Deflation exists if price level falls which would be the result of a fall in AD or an increase in AS.
Just to note:
If price level increases by a larger gap than the last change in price level per given time period, inflation is increasing.
If price level increases by the same gap than the last change in price level per given time period, inflation is constant.
If price level increases by a smaller gap than the last change in price level per given time period, inflation is decreasing.

Here's a good evaluation for your exam if you're doing economics btw:
But ultimately that effect depends on where the positioning of the AD curve is relative to AS. If AD increases and it is on AS at full employment, prices will rise at the maximum rate. If AD is on AS at spare capacity and shifts left by a gap which does not result in it leaving spare capacity, price level will not change.

(edited 11 years ago)

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AD/AS curve help.

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