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The AD-AS or Aggregate Demand-Aggregate Supply model is a macroeconomic model
Model (macroeconomics)

A model in macroeconomics is a logical, mathematical, and/or computational framework designed to describe the operation of a national or regional economy, and especially the dynamics of aggregate quantities such as the total amount of goods and services produced, total income earned, the level of employment of productive resources, and the le...
 that explains price level
Price level

A price level is a hypothetical measure of overall prices for some set of Good s and Service s, in a given region during a given interval, normalized relative to some base set....
 and output
Output (economics)

Output in economics is the total Value of all of the good and Service production in an entity's economy. It is a concept used in macroeconomics, or the study of the economic transactions of broad groups such as countries....
 through the relationship of aggregate demand
Aggregate demand

In economics, aggregate demand is the total demand for final goods and services in the economy at a given time and price level. It is the amount of goods and services in the economy that will be purchased at all possible price levels....
 and aggregate supply
Aggregate supply

In economics, aggregate supply is the total supply of goods and services produced by a national economy during a specific time period. It is the total amount of goods and services in the economy available at all possible price levels....
. It was first put forth by John Maynard Keynes in his work The General Theory of Employment, Interest, and Money. It is the foundation for the modern field of macroeconomics
Macroeconomics

Macroeconomics is a branch of economics that deals with the performance, structure, and behavior of a national or regional economy as a whole....
, and is accepted by a broad array of economists, from Libertarian, Monetarist supporters of laissez-faire
Laissez-faire

Laissez-faire is a term used to describe a policy of allowing events to take their own course. The term is a French language phrase literally meaning "let do"....
, such as Milton Friedman
Milton Friedman

Milton Friedman was an United States economist, statistician and public intellectual, and a recipient of the Nobel Memorial Prize in Economic Sciences....
 to Socialist, Post-Keynesian
Post-Keynesian economics

Post-Keynesian economics is a school of thought with its origins in The General Theory of John Maynard Keynes, although its subsequent development was influenced mainly by Joan Robinson, Nicholas Kaldor and Paul Davidson ....
 supporters of economic interventionism
Economic interventionism

Economic interventionism or economic planning is any action taken by a government, beyond the basic regulation of fraud and enforcement of contracts, in an effort to affect its own economics....
, such as Joan Robinson
Joan Robinson

Joan Violet Robinson was a Post-Keynesian economics who was well known for her knowledge of monetary economics and wide-ranging contributions to economic theory....
.

AD/AS model can be used to demonstrate two significant macroeconomic events; the Phillips Curve
Phillips curve

The Phillips curve is a historical inverse relation between the rate of unemployment and the rate of inflation in an economy. Stated simply, the lower the unemployment in an economy, the higher the rate of increase in nominal wages in the economy....
 relationship, and stagflation
Stagflation

Stagflation is an economic situation in which inflation and economic stagnation occur simultaneously and remain unchecked for a period of time. The Portmanteau word "stagflation" is generally attributed to British politician Iain Macleod, who coined the term in a speech to Parliament of the United Kingdom in 1965....
.

The Phillips Curve
Phillips curve

The Phillips curve is a historical inverse relation between the rate of unemployment and the rate of inflation in an economy. Stated simply, the lower the unemployment in an economy, the higher the rate of increase in nominal wages in the economy....
 shows the relationship between changes in price (inflation
Inflation

In economics, inflation is a rise in the general price level of goods and services in an economy over a period of time. The term "inflation" once referred to increases in the money supply ; however, economic debates about the relationship between money supply and price levels have led to its primary use today in describing price inflatio...
) and unemployment.






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The AD-AS or Aggregate Demand-Aggregate Supply model is a macroeconomic model
Model (macroeconomics)

A model in macroeconomics is a logical, mathematical, and/or computational framework designed to describe the operation of a national or regional economy, and especially the dynamics of aggregate quantities such as the total amount of goods and services produced, total income earned, the level of employment of productive resources, and the le...
 that explains price level
Price level

A price level is a hypothetical measure of overall prices for some set of Good s and Service s, in a given region during a given interval, normalized relative to some base set....
 and output
Output (economics)

Output in economics is the total Value of all of the good and Service production in an entity's economy. It is a concept used in macroeconomics, or the study of the economic transactions of broad groups such as countries....
 through the relationship of aggregate demand
Aggregate demand

In economics, aggregate demand is the total demand for final goods and services in the economy at a given time and price level. It is the amount of goods and services in the economy that will be purchased at all possible price levels....
 and aggregate supply
Aggregate supply

In economics, aggregate supply is the total supply of goods and services produced by a national economy during a specific time period. It is the total amount of goods and services in the economy available at all possible price levels....
. It was first put forth by John Maynard Keynes in his work The General Theory of Employment, Interest, and Money. It is the foundation for the modern field of macroeconomics
Macroeconomics

Macroeconomics is a branch of economics that deals with the performance, structure, and behavior of a national or regional economy as a whole....
, and is accepted by a broad array of economists, from Libertarian, Monetarist supporters of laissez-faire
Laissez-faire

Laissez-faire is a term used to describe a policy of allowing events to take their own course. The term is a French language phrase literally meaning "let do"....
, such as Milton Friedman
Milton Friedman

Milton Friedman was an United States economist, statistician and public intellectual, and a recipient of the Nobel Memorial Prize in Economic Sciences....
 to Socialist, Post-Keynesian
Post-Keynesian economics

Post-Keynesian economics is a school of thought with its origins in The General Theory of John Maynard Keynes, although its subsequent development was influenced mainly by Joan Robinson, Nicholas Kaldor and Paul Davidson ....
 supporters of economic interventionism
Economic interventionism

Economic interventionism or economic planning is any action taken by a government, beyond the basic regulation of fraud and enforcement of contracts, in an effort to affect its own economics....
, such as Joan Robinson
Joan Robinson

Joan Violet Robinson was a Post-Keynesian economics who was well known for her knowledge of monetary economics and wide-ranging contributions to economic theory....
.

Modeling

The AD/AS model can be used to demonstrate two significant macroeconomic events; the Phillips Curve
Phillips curve

The Phillips curve is a historical inverse relation between the rate of unemployment and the rate of inflation in an economy. Stated simply, the lower the unemployment in an economy, the higher the rate of increase in nominal wages in the economy....
 relationship, and stagflation
Stagflation

Stagflation is an economic situation in which inflation and economic stagnation occur simultaneously and remain unchecked for a period of time. The Portmanteau word "stagflation" is generally attributed to British politician Iain Macleod, who coined the term in a speech to Parliament of the United Kingdom in 1965....
.

The Phillips Curve
Phillips curve

The Phillips curve is a historical inverse relation between the rate of unemployment and the rate of inflation in an economy. Stated simply, the lower the unemployment in an economy, the higher the rate of increase in nominal wages in the economy....
 shows the relationship between changes in price (inflation
Inflation

In economics, inflation is a rise in the general price level of goods and services in an economy over a period of time. The term "inflation" once referred to increases in the money supply ; however, economic debates about the relationship between money supply and price levels have led to its primary use today in describing price inflatio...
) and unemployment. This relationship is fundamental to Keynesian Economics because changes in the money supply are seen to be non-neutral.

To model the Phillips Curve using the AD/AS model, a rightward shift in the AD curve is shown. This demonstrates how Aggregate Demand side managers such as the federal government and the monetary authority(the Fed) are able to throttle the economy, opting for either high inflation with low unemployment, or high unemployment with low inflation. However, the Phillips Curve was shattered during the 1970s oil crisis, with oil prices constituting a cost shock that shifted the AS curve to the left. (Previously, the Phillips Curve
Phillips curve

The Phillips curve is a historical inverse relation between the rate of unemployment and the rate of inflation in an economy. Stated simply, the lower the unemployment in an economy, the higher the rate of increase in nominal wages in the economy....
 had been assuming that the AS curve stays pretty much constant, with only the AD curve shifting right or left based on economic growth
Economic growth

Economic growth is the increase in the amount of the goods and services produced by an economics over time. It is conventionally measured as the percent rate of increase in real gross domestic product, or real GDP....
.) The phenomenon in macroeconomics of stagflation
Stagflation

Stagflation is an economic situation in which inflation and economic stagnation occur simultaneously and remain unchecked for a period of time. The Portmanteau word "stagflation" is generally attributed to British politician Iain Macleod, who coined the term in a speech to Parliament of the United Kingdom in 1965....
 was being witnessed: stagnant growth with high inflation. Policy makers were helpless to do anything because they can only affect Aggregate Demand, not Aggregate Supply. The Phillips Curve was done away with and policy makers were at a loss.

The Federal Reserve Governor at the time Arthur F. Burns
Arthur F. Burns

Arthur Frank Burns was an United States economist. He served as Chairman of the Federal Reserve from 1970 to 1978....
 attempted to solve the problem. He was seen as dovish on inflation and preferred keeping the economy at full employment
Full employment

In macroeconomics, full employment is a condition of the national economy, where nearly all persons willing and able to work at the prevailing wages and working conditions are able to do so....
. He pursued a "loose" monetary policy and increased the money supply. Some today now contest Mr. Burns actions because had the oil shock been a permanent shock to supply thus shifting the LRAS curve left, he only made the situation worse by keeping us at a higher rate of inflation. His policy was quite different from two Fed Chairmans later Paul A. Volcker, who is seen as the most hawkish governor of all times.

AD curve

The AD curve is defined by the IS-LM-FE model (Mundell-Fleming model) equilibrium income at different price levels. The equation for the AD curve for flexible exchange rates is:

The equation for the AD curve for fixed exchange rates is:

AS curve

The AS curve is defined by the labour market equilibrium at different price levels. Since the equilibrium in the labour market stays the same at different price levels in the long run, the LAS curve is a vertical line at equilibrium income. In the short run, the AS curve turns clockwise because the labour market can't react to surprises immediately. The equation for the short run AS curve is:

See also

  • IS/LM model
    IS/LM model

    The IS/LM model is a macroeconomic tool that demonstrates the relationship between interest rates and real output in the goods and services market and the money market....
  • AD-IA Model
    AD-IA Model

    The Aggregate Demand-Inflation Adjustment model builds on the concepts of the IS/LM model and the AD-AS models, essentially in terms of changing interest rates in response to fluctuations in inflation rather than as changes in the money supply in response to changes in the price level....
  • DAD-SAS model
    DAD-SAS model

    The DAD-SAS model is a Model based on the AD-AS model but that looks at the different incomes at different inflation levels....


External links

  • brief explanation of the AD-AS model
  • explains the AD-AS model and explains its relation to the IS/LM model
  • includes an interactive graph demonstrating inflationary changes in a graph based on the AD-AS model
  • includes an interactive AD-AS graph that tests one's knowledge of how the AD and AS curves shift under different conditions


Scholarly articles

  • Dutt, Amitava K.and Skott, Peter. Working Papers 2005-11, University of Massachusetts Amherst, Department of Economics. 2005.
  • Palley, Thomas I. . Eastern Economic Journal, Fall 1997.
  • Amitava Krishna Dutt and Skott, Peter. Eastern Economic Journal, Eastern Economic Association, vol. 22(3), pages 313-331, Summer 1996.