How to Draw the AD-AS Model: Graphing Aggregate Demand & Supply Curves

📚 What is the AD-AS Model?

The Aggregate Demand-Aggregate Supply (AD-AS) model is a macroeconomic model that explains price level and output through the relationship of aggregate demand and aggregate supply. It's a cornerstone of macroeconomic analysis.

📜 A Brief History

The AD-AS model evolved from Keynesian economics, particularly the work of John Maynard Keynes in the 1930s. It provides a framework for understanding economic fluctuations and the effects of fiscal and monetary policy.

🔑 Key Principles

• 📈 Aggregate Demand (AD): Represents the total demand for goods and services in an economy at a given price level. It slopes downward because as the price level decreases, purchasing power increases, leading to higher demand.
• 🏭 Aggregate Supply (AS): Represents the total quantity of goods and services that firms are willing to supply at a given price level. There are two types: Short-Run Aggregate Supply (SRAS) and Long-Run Aggregate Supply (LRAS).
• ⏳ Short-Run Aggregate Supply (SRAS): Is upward sloping because wages and other input costs are sticky in the short run. Higher prices lead to higher profits and increased output.
• ⛰️ Long-Run Aggregate Supply (LRAS): Is vertical at the potential output level of the economy. It represents the economy's maximum sustainable output, determined by factors like technology, capital, and labor.
• ⚖️ Equilibrium: Occurs where AD intersects with SRAS. In the long run, it occurs where AD, SRAS, and LRAS intersect.

✍️ Drawing the AD-AS Model: A Step-by-Step Guide

1. Step 1: Set Up the Axes
   • 📏 Draw a graph with the price level (P) on the vertical axis and real GDP (Y) on the horizontal axis.
2. Step 2: Draw the Aggregate Demand (AD) Curve
   • 📉 Draw a downward-sloping curve, labeling it 'AD'. Remember, this curve represents the inverse relationship between the price level and the quantity of real GDP demanded.
3. Step 3: Draw the Short-Run Aggregate Supply (SRAS) Curve
   • 📈 Draw an upward-sloping curve, labeling it 'SRAS'. This curve represents the direct relationship between the price level and the quantity of real GDP supplied in the short run.
4. Step 4: Draw the Long-Run Aggregate Supply (LRAS) Curve
   • 📍 Draw a vertical line, labeling it 'LRAS'. This line represents the potential output of the economy, which is independent of the price level in the long run. It should intersect the horizontal axis at the potential GDP level ($Y_p$).
5. Step 5: Identify the Equilibrium
   • 🎯 The short-run equilibrium is where the AD and SRAS curves intersect. This point determines the equilibrium price level ($P^*$) and the equilibrium real GDP ($Y^*$).
   • 🎗️ The long-run equilibrium is where all three curves (AD, SRAS, and LRAS) intersect. At this point, the economy is operating at its potential output.

📊 Real-world Examples

• 🦠 COVID-19 Pandemic: The pandemic caused a decrease in aggregate demand due to reduced consumer spending and investment. The AD curve shifted left, leading to lower output and potentially lower prices. Supply chain disruptions also shifted the SRAS curve leftward, exacerbating the economic downturn.
• 💰 Fiscal Stimulus: Government spending increases (fiscal stimulus) shift the AD curve to the right, leading to higher output and prices. For example, infrastructure spending can boost aggregate demand.
• 🏦 Monetary Policy: Lowering interest rates by the central bank increases aggregate demand, shifting the AD curve to the right. This can stimulate economic growth but may also lead to inflation if the economy is near full employment.

📝 Practice Quiz

1. ❓ What does the AD curve represent?
2. ❓ What is the shape of the LRAS curve and why?
3. ❓ How does an increase in government spending affect the AD-AS model?
4. ❓ Explain the difference between SRAS and LRAS.
5. ❓ What happens to the equilibrium when AD shifts left?
6. ❓ How does monetary policy influence the AD curve?
7. ❓ What is the significance of the intersection of AD, SRAS, and LRAS?

💡 Conclusion

The AD-AS model is a powerful tool for understanding macroeconomic conditions and the effects of various policies. By mastering the art of drawing and interpreting the AD-AS model, you gain valuable insights into how the economy functions.