Understanding and creating graphs are critical skills in macroeconomics. In this article, you’ll get a quick review of the aggregate demand-aggregate supply (AD-AS) model, including:
- what it’s used to illustrate
- key elements of the model
- some examples of questions that can be answered using that model.
What the AD-AS model illustrates
The AD-AS (aggregate demand-aggregate supply) model is a way of illustrating national income determination and changes in the price level. We can use this to illustrate phases of the business cycle and how different events can lead to changes in two of our key macroeconomic indicators: real GDP and inflation.
Key Features of the AD-AS model
- Two axes: a vertical axis labeled “Price level” or “PL” and a horizontal axis labeled “real GDP.”
- A downward sloping aggregate demand curve labeled “AD.” An upward sloping short-run aggregate supply curve labeled “SRAS.”
- An equilibrium price level and real GDP. These should be labeled as indicated in the question.
- A vertical long-run aggregate supply curve labeled “LRAS.” The LRAS should be vertical at the full employment output. The placement of the LRAS curve will depend on whether the economy has an output gap or is in long-run equilibrium. For example, the economy in the graph shown here is in a recession
Helpful reminders for the AD-AS model
- Label any equilibrium on the axis, not the interior
- The placement of the LRAS gives important information about the state of the economy. For example, if the equilibrium output is to the left of the LRAS, then the economy is in a recession.
Most common uses of the AD-AS model
- Showing a recession, with
representing current output and representing full employment output. Note that is less than during a recession.
Showing an economy in long-run equilibrium, with Y_1 representing current and Y_f representing full employment output. Note that Y_1 equals Y_f in long-run equilibrium.
-Showing an economy producing beyond full employment output, with Y_1 representing current output and Y_f representing full employment output. Note that Y_1 is greater than Y_f when an economy is producing more than full employment output.
Try it yourself
Here is an example of a question using the AD-AS model from the 2013 AP Macroeconomics exam. Try to solve it on your own, and then click on the solution to compare your work to the correct answer.
Want to join the conversation?
- what is the major government goal in an economy(2 votes)
- for the general wellbeing of their citizens to increase. this is done by having an effective economy(3 votes)
- how can the level of output be past the full employment output?(2 votes)
- This can occur when there is an inflationary gap, which occurs when the demand exceeds production due to higher levels of overall employment, increased trade activities, or elevated government expenditure.(2 votes)
- How can you illustrate an AD-AS chart when there is a change in a factor like government regulation or spending? We have to show how the chart changes in my economics class and I still can't figure it out.(1 vote)
- Sorry you got a response so late!
When increased levels of government spending occur, this shifts Aggregate Demand (AD) to the right, as it essentially increases demand/consumption for certain products. Whereas increased government regulations typically shifts Aggregate Supply (AS) to the left, as more oversight can heighten the cost of production for businesses.(3 votes)
- How does government intervention play into the AD-AS model? And how does Hayek's idea that government intervention cannot increase real GDP in the long run relate to the AD-AS?(1 vote)
- At the point
Y1 > Yf, why saying it
positive output gap(1 vote)
- Since the equilibrium is above the Long Run Aggregate Supply, the economy is producing beyond, or more than the long term production possibilities of a country. Since it is more than, it is a positive output(0 votes)