A real-world example of the concepts behind the AD-AS model is the oil shocks the United States experienced in the late 1970s. In this video, we break down some of the events going on at the time and use the AD-AS model to see if our predictions using this model match what really happened. Created by Sal Khan.
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- What is the difference between Demand-Pull Inflation and Cost-push Inflation?(4 votes)
- Demand pull inflation is caused by an aggregate demand shift to the right due to a shock in one of the determinants of GDP such as government spending or investment. As the AD curve shifts to the right it intersects with the short run AS curve at a higher output and a higher Price Level. If the aggregate demand shift results in some level of output beyond the natural level of output then, in the long run, the level of output will fall back onto the long run AS curve but with the added inflation caused by the earlier shift.
With Cost Push, the cause is in a sudden scarcity of factors or rather an increase in factor costs. This shifts the short run AS curve to the left causing output to fall below the natural level of output and prices to increase. Once again, in the long run output returns to be inline with the long run AS curve but at a higher average Price Level.
Both are inefficient and preferably avoided as they result in price inflation without a long run benefit for the level of output but, as Sal states, the thing to notice is that with demand pull at least the economy has benefited from a temporary increase in real GDP. If you want more info on demand pull check out the video here: https://goo.gl/Bv6R74(12 votes)
- Does cost-push inflation self correct? If so how? (please help!)(3 votes)
- This is quite an interesting question. I even think is quite debated between economist. As for myself, i think it doesn't quite have a self correction mechanism in certain situations. Either way the government can always engage in fiscal policy and the Fed can do the same thing in monetary policy to smooth these changes.
If you investigate more on the situation talked about in the video, that is the Oil supply shock originated by the Organization Of Petroleum Exporting Countries - OPEC you see that they ended up lifting the embargo up and lowering prices.(3 votes)
- What is the role of oil in the 2007 financial crisis? In summer 2007 the barrel price reached a an historical maximum at around nominal $140 after four years of continuous increase. Is it reasonable to think that the financial crisis was triggered by the rising cost of energy?(1 vote)
- The 2008 financial crisis was caused mainly by the domino effect initiated by Lehman Brothers (a major financial player in Wall Street) going bankrupt, which called an examination of the financial instruments that were being used in the market to, supposedly, better allocate risk. However, systemic risk (the risk that one sector´s downfall could cause another´s) was underestimated, and here we are.
There´s a comprehensive section on the 2008 crisis on this website, you should check it out if you feel like delving into the subject.(4 votes)
- how do you calculate and find the value of consumption or gross private domestic investment?(2 votes)
- Well, you can perform surveys like the BLS does - see the https://www.khanacademy.org/economics-finance-domain/macroeconomics/inflation-topic/cost-of-living-tutorial/v/actual-cpi-u-basket-of-goods video for an example on the CPI.(1 vote)
- What factors would affect a change in wages, which would raise inputs for firms and shift SRAS to the left, affecting prices?
Is it fair to say an increase in wages will cause inflation?(2 votes)
- There could be many factors that increase wages, such as increasing union membership, increasing competition with other companies, changes in the process of creating products, minimum wage laws, a labor shortage, etc. Most of the time, increasing wages will cause increasing demand, which causes inflation. as was shown in the microeconomics playlist. However, this is mainly inflation in consumer prices, not asset prices, which might actually deflate because the companies have less money to spend on these assets.(1 vote)
- If we assume that ASSR shifts to the right we would have deflation?(1 vote)
- Yes, there would be deflation and at the same time, the economy would grow. New technologies do this all the time, as they allow producers to make more products more cheaply. We would have deflation as a result if the Federal Reserve did not increase the money supply in response to new technologies.(2 votes)
- At4:03, he says if supply goes down, prices go up. So why is it that the aggregate supply curve doesn't reflect that statement? It looks like high supply(production)-high price///low supply, low price.(1 vote)
- He is talking about a shift in the supply curve, not movement along the supply curve.(2 votes)
- Why a decrease in MPC won't only have a negative affect on MPC?(1 vote)
- I'm not quite sure what you are asking. Can you clarify that?(1 vote)
- During Cost-Push Inflation period, does Unemployment rate rise propotional to the rate of decreasing Real GDP or rate of Inflation ?(1 vote)
- Unemployment tends to rise inversely proportional to the ∆GDP. However, unemployment is distributed unevenly, so don't count on unemployment increase being perfectly proportional to the rate of decrease of real GDP.(1 vote)
- This AD/AS series has me a little confused, when the supply of goods goes up, shouldn't the consumer be willing to pay less for it, hence driving prices down?(1 vote)
- When the supply goes up, the curve shifts right, so you may have your directions mixed up.(1 vote)
In the last two videos, we explored situations where the aggregate demand curve shifted to the right and that caused inflation. That's actually called demand-pull inflation. What I want to do in this video is study a situation where the short-run aggregate supply curve shifts to the left and that causes inflation. And that's called cost-push inflation. So let's just start off with our standard graph. So this is aggregate prices. This is real aggregate productivity. Real GDP right here. I'm going to focus things on the short run. Aggregate demand right over here. That is our aggregate demand curve. Aggregate supply in the short-run. This is what we're going to focus on, might look something like that. So this is aggregate supply in the short-run. And this is our current level of prices. And the reason why I draw aggregate supply in the short-run as this curve that keeps getting steeper and steeper. Or if you think in algebraic terms, the slope keeps getting larger and larger as you go to the right, one way to think about it is: if the real GDP is down here and maybe performing well below potential, there is a lot of excess capacity in the economy: excess labor capacity, excess factory capacity. So if you want more productivity out of that economy, people aren't going to demand much more. Prices won't have to go up more. There's a lot of slack in the economy. While as GDP gets higher and higher, maybe even going beyond its potential, starts to get overheated and in order for people to get very high levels of utilization, essentially get more people to enter the labor market, work longer hours, work overtime, the prices are going to essentially have to go up. So over here, for some increment in GDP, prices don't have to go up so much. So you have a lower slope than over here. For that same increment in GDP, prices have to go up dramatically. With that out of the way, let's think about what would happen if the aggregate supply curve were to shift to the left. We can also think about "Why would it shift to the left?" So let's just shift it to the left. It might look something like that. At any given point, I try to shift it to the left. You see a new equilibrium price and equilibrium GDP. This is the old equilibrium price and the old equilibrium GDP. This is the new equilibrium price and the new equilibrium GDP. You see, you definitely had inflation. Price went up, but this is worse, depending on how you view things. But generally, this is worse than demand-pull inflation. Because at least with demand-pull inflation, you had inflation happening, but real GDP increased more as things get overheated. Prices went up, but your GDP actually contracts. This is a situation where you might have heard the word before: this is stagflation. Inflation with stagnation. So this is stagflation. There's two very notable examples of this in recent US history. In 1973, you had the Arab oil embargo. It was apparently due in response to the US support of Israel in the Yom Kippur War. So you had the 1973 oil embargo. In 1979, you have your revolution in Iran. Iran was a major oil producer then. It continues to be, but it was particularly so in 1979. So, during all the chaos, during the revolution, Iran's oil productivity dropped dramatically. So you had an oil crisis. The reason why oil crises would shift the curve to the left... In both of these situations, the supply of oil drops dramatically. So if the supply of oil, and this is kind of a micro-phenomenon, if the supply of something drops dramatically, the price of that thing is going to go up dramatically. And in the 70's, oil was an even bigger part of the economy than it is now. You probably remember if you were around in the 70's. Very very large cars that had very bad gas mileage. Other uses of oil were also much less efficient in the 1970s. So it was a big input into the US economy. If all of a sudden, a major input's price becomes much more expensive, you could view it as one of two ways: For a given level of productivity, suppliers will want to charge more. If you want me to deliver to your house, if you want me to run a truck, so for a given level of productivity, suppliers will charge more. Or you could view that at a given level of price, suppliers will want to produce less. So at a given price, say this price over here, a supplier will want to produce less. Because they are not getting as much real profit. So you could view it as a shift to the left. Or you could even view it at a given level of productivity, if you want to produce at that level, you're going to have to pay me more so I can offset my price increases. So you can also view it as a shift up. Either one. But we'll think of it as a shift left in this context. So you see, this does describe what happened during these two oil crises in the 1970's. Because of this increase in the price of oil, at any given price, suppliers were willing to supply less. Aggregate short-run supply shifts to the left. You have the inflation, and you also have the stagnation. Real GDP goes down.