Chapter 10:  The AD-AS Model

    The Aggregate Demand-Aggregate Supply model provides a means to analyze and explain the determinants of output/income, employment, and price level.  Recall that it is very similar to the Demand-Supply model we used in Chapter 3.  The difference is that here we are dealing with "aggregates" or totals.  The assumption is that the economy will always tend toward that level of output/income and price level at which AD = AS.  As in Chapter 3, your author first develops the AD function and then those non-price-level factors that will cause the AD function to change (shift).  Next, he develops the AS function and those factors that will shift AS.  Finally, we put the two functions together and attempt to explain what happens when either AD or AS change.

The Aggregate Demand Function:

We observe an inverse or negative relationship between the price level and the dollar value of total spending or aggregate demand. We can explain this relationship by three effects of a change in price level.  We cover this extensively in class, but again I refer you to pages 188 and 189 in your text.  You should be comfortable taking either an increase or decrease in the price level and explaining how each of the three effects will act to cause a change the dollar value of aggregate demand (total spending).

Changes in Aggregate Demand:

Aggregate Demand will change (shift the AD curve) when any one or more of the non-price level determinants of AD change.  Figure 10.2 is an excellent study aid.  The non-price level determinants of AD are:

        1.  Consumption

        2.  Investment

       3.  Government

        4.  Net exports

Aggregate Supply :

 Aggregate Supply is a little more complicated.  We must consider the relationship between the price level and AS (output) in both the long-run and the short-run. In the long-run, the AS schedule can be drawn as a vertical line, intersecting the horizontal axis at the full-employment level of real GDP.  However, in the short-run AS is directly related to the price level (upward sloping).   

Changes in Aggregate Supply:  From my perspective, the author makes this far more complicated than it need be at this level.  I suggest that we simply think about those factors we dealt with in Chapter 3.  Recall that resource or input  prices and technology (productivity) both affect the cost of production and changes in the cost of production cause changes in the supply of any good.  If we apply that to Aggregate Supply, we can say that any change that increases the cost of producing goods and services will cause the AS curve to shift to the left.  Likewise, if the cost of producing goods and services falls, the AS curve will shift to the right. Figure 10.5 is a great study aid.   

Equilibrium in the AD-AS Model:

Figures 10.6 through 10.10 are important!!  Make sure you understand these relationships!!