The AD-AS model is a workhorse macroeconomic framework that plots aggregate demand (AD) and aggregate supply (AS) curves against the overall price level (vertical axis) and real output or GDP (horizontal axis). Equilibrium occurs where the two curves intersect, determining the economy's price level and real output in the short run and long run.
Aggregate demand slopes downward and represents total spending in the economy: C + I + G + (X − M). It shifts with changes in consumer confidence, fiscal policy, monetary policy, exchange rates, or net exports. A central bank cutting interest rates, for example, shifts AD rightward.
Short-run aggregate supply (SRAS) typically slopes upward because some input prices, especially nominal wages, are sticky. It shifts with input costs, productivity shocks, supply-chain disruptions, or tax changes on producers. The 1973 oil shock is the canonical example of a leftward SRAS shift, producing stagflation.
Long-run aggregate supply (LRAS) is usually drawn vertical at potential output, reflecting the classical view that in the long run output depends on capital, labor, technology, and institutions — not the price level.
The model is used to analyze:
- Demand-pull inflation: rightward AD shift along an upward-sloping SRAS.
- Cost-push inflation: leftward SRAS shift, raising prices and lowering output.
- Recessionary and inflationary gaps: where short-run equilibrium sits below or above LRAS.
- Policy trade-offs: how fiscal stimulus or monetary tightening moves AD relative to supply constraints.
The framework synthesizes Keynesian short-run analysis with classical long-run neutrality of money, and is standard in intermediate macroeconomics textbooks such as Mankiw's Macroeconomics and Blanchard's Macroeconomics. While it abstracts away from microfoundations and expectations dynamics — which DSGE and New Keynesian models address more rigorously — AD-AS remains the most accessible diagram for communicating macro shocks to policymakers, students, and Model UN delegates debating economic crises in ECOFIN or the IMF.
Example
After the 1973 OPEC oil embargo, the U.S. economy experienced a leftward shift in short-run aggregate supply, producing simultaneously higher prices and lower output — a textbook AD-AS illustration of stagflation.
Frequently asked questions
IS-LM holds the price level fixed and focuses on interest rates and output in the goods and money markets, while AD-AS makes the price level endogenous and incorporates supply-side dynamics.
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