Chapter Ten: Module Summary -- The Fixed Price AD/AS Model

  • The Fixed Price AD/AS model is appropriate for the very short run, or when the economy is in a recessionary gap well below potential output.

  • Prices in this model are assumed to be fixed. The AS curve is perfectly horizontal at the fixed price level.

  • When the Aggregate Demand curve shifts in the fixed price model, only output changes, prices are unchanged.

  • The economy's equilibrium condition can be written as Y = AD, or Y = C + I + G + NX.

  • The level of consumption is positively related to disposable income, wealth, and expectations of future income. It is negatively related to interest rates.

  • The equation for the consumption function is: C = Ca + MPC (DI) where C = total consumption; Ca = autonomous consumption, consumption that is independent of the level of income; MPC = marginal propensity to consume, or the change in consumption divided by the change in disposable income; and DI = disposable income.

  • Since all Disposable Income is either consumed or saved, then the portion of additional disposable income not consumed must be saved. Therefore, MPC + MPS = 1.

  • The level of investment in positively related to capacity utilization and business confidence. It is negatively related to taxes and interest rates.

  • In equilibrium, Y = Ca + MPC (DI) + I.

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