Aggregate Supply and Aggregate Demand (AS-AD) Model

  • 0:01 What Are Aggregate…
  • 0:57 The Curves
  • 2:08 The Axes
  • 3:23 Moving the Graphs
  • 4:53 Lesson Summary
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Lesson Transcript
Instructor: Kevin Newton

Kevin has edited encyclopedias, taught middle and high school history, and has a master's degree in Islamic law.

Supply and demand models are useful for examining the behavior of one good or market, but what about looking at a whole economy? Luckily, the aggregate supply and aggregate demand model lets us do just that.

What Are Aggregate Demand and Aggregate Supply?

By now, you've probably seen the usefulness of supply and demand graphs. After all, the concepts they demonstrate make quite a bit of sense. For the demand graph, the more something costs, the less people are willing to buy, while the less something costs, the more people are willing to buy. And for the supply graph, the opposite is true - as prices rise, suppliers seek to sell more, while falling prices mean less of a good will be supplied.

That's all fine and good for analyzing one good at a time, but that's small potatoes for a macroeconomist. They need to be able to examine the behavior of a whole economy at once. To accomplish this, economists calculate the aggregate demand and aggregate supply of an economy. Aggregate demand is the total amount of demand that an economy has, while aggregate supply is the total amount of supply an economy is capable of producing.

The Curves

That's quite a bit of power in one model! However, there is a hitch. Since this is a whole economy, things move a bit more slowly. After all, if the demand for labor suddenly increases, it's not like we can just clone fully grown and capable people! Instead, economists use two supply curves. Now, this may sound confusing, but let me explain. It goes back to the idea of elasticity, or how quickly a good adjusts to changes in price or quantity. Aggregate supply tends to be fairly inelastic in the short run, when firms are finishing up their current contracts, so it takes the shape of a traditional supply curve, sloping up over time. This curve is the short run aggregate supply curve, often labeled SRAS.

However, economies are perfectly elastic at in the long run. Thus as an economy figures out what goods are in demand, it can adjust perfectly if given enough time. As economists, we don't have to put a time frame on this adjustment period, but can just say that it will get there eventually. This is the long run aggregate supply curve, abbreviated LRAS.

The Axes

As you can tell, we have three lines to chart on this model, and our axes have changed as well. Traditionally, you are used to graphing supply and demand with respect to quantity and price. We're still going to do that, but we're going to give them different names to reflect the fact that these are aggregate, or economy-wide, changes. First, instead of price, you will often see price level or inflation on the vertical axis. Either is fine, and the terms just refer to the fact that, like any specific good, changes across an economy will result in changes to price. Rather than have billions and trillions of dollars represented on the vertical axis, we just use inflation.

The horizontal axis is where quantity would typically go. However, here we're going to see the total value of goods across the whole economy. In other words, we will measure the real GDP on the x-axis. Now that may sound confusing, since you're used to putting a dollar amount on the y-axis and a quantity on the x-axis. But remember, whenever you were looking at prices in the past, the change was what was important, and inflation is nothing but a measure of change. Likewise, consider what we are measuring the change of. If you guessed the economy, then you'll know that the best measure of an economy is real GDP.

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