Dynamic AD-AS Model: Introduction - Online Tutor, Practice Problems & Exam Prep

The dynamic ADAS model enhances the standard aggregate demand and supply framework by accounting for economic growth over time. In this model, both long-run and short-run aggregate supply curves shift rightward annually due to factors like technological advancements and population growth. Aggregate demand also increases, driven by higher consumption, investment, and government spending. This results in a new equilibrium with a higher potential GDP while maintaining a stable price level, illustrating the continuous expansion of the economy.

Dynamic AD-AS Model: Introduction

Alright. So now let's build upon that aggregate demand, aggregate supply model to make it fit a little better in real world situations. Now I want to make a point before we dive into the dynamic ADAS model that a lot of professors skip this altogether. They focus on just the regular ADAS model and they don't do the dynamic. I'm adding it in here because a lot of textbooks do include this information. So double check with your professor if you're going to need to know this and if not, easy peasy. Just skip right over it. Alright. So let's go ahead here.

The dynamic ADAS model. So remember, when we do the ADAS model, we're talking about that model that looks something like this. Right? We had our aggregate demand, our aggregate supply in the short run. Short run aggregate supply and then our long run aggregate supply. Right? And here was our price level in the economy, and here was our real GDP. Okay? So we found this equilibrium in the long run, and then we were shifting the curves to find different short-run equilibriums, etc. So we studied that standard ADAS model. We made some assumptions. There was no long-run inflation. We were always holding this LRA, LRAS, the long-run model, long-run aggregate supply. We were holding it constant. So there was no long-run inflation, no long-run growth and potential GDP is static. Right? So that was a big assumption we were making. We were just leaving that potential GDP where it is. But that doesn't correctly predict what generally happens during recessions and inflation.

So the standard model, what it usually shows us when we were doing our analysis is that a recession caused by decreased aggregate demand, so aggregate demand would be shifting to the left. Well, it would lead to lower price levels. Right? So what we have here, our original price level, and then our lower price level here in the short run during the recession. So price 1 and price 2, right? It led to lower price levels and that actually doesn't happen very often in recessions. As you can see, it hasn't even occurred since the 1930s.

So, what we do in the dynamic ADAS model is we try to remove those assumptions where we have that static potential GDP. That long-run aggregate supply. So what we're going to do is we're going to try to fix this by actually shifting the curves to, to compensate for growth in the economy. We're actually going to compensate for the economic growth that's just generally happening. So what we're going to see is that the potential GDP in the economy increases over time. Over time, we have new technology. We have increases in the labor force. There's more population. There's more factories built. There's just more stuff. So our potential GDP is growing over time. So in the dynamic ADAS model, Long Run Aggregate Supply shifts to the right yearly. So we're going to be shifting the aggregate, the long-run aggregate supply to the right. This is because it's increasing. And just like the long-run aggregate supply is increasing, well, short-run aggregate supply is increasing for those same reasons. So we're going to be shifting it to the right yearly, as well. Okay? So we're going to see these shifts happening in these curves from one year to the next. We're going to be shifting them to the right. Okay?

And guess what? Aggregate demand, well that tends to increase over time as well. So the Aggregate Demand Curve, we're also going to be shifting it to the right yearly. Now Aggregate Demand is shifting for different reasons, but it's still generally increasing year over year. There's increases in the population year over year and increases in income leading to higher consumption, more spending. The growing economy leads to higher investment from firms. Firms are spending money growing their businesses. And the growth in the population and economy generate more need for government services. So higher consumption, higher investment, higher government purchases, all our portions of aggregate demand are increasing, generally, year over year. Okay?

So what we're going to see in the dynamic model, we're basically just going to be shifting all the curves to the right to a new equilibrium in the following year, further to the right, okay? At a higher potential GDP.

So let's look at what it looks like when we have this expansion, this year over year expansion and we have our initial. So what we'll do is we'll draw our initial situation which will just be something like this. And let's label our graph. We've got our price level over here. We've got our real GDP on this axis. Let me get out of the way so you can see everything. And then we'll have aggregate demand or downward demand, double d's. Long run aggregate supply and short run aggregate supply. So I'm going to label these all one. Actually, I'm going to do this in a different color so I can use red for the next. I'll label everything in green here. So long-run aggregate supply 1, short-run aggregate supply 1, and aggregate demand 1. Okay? And then we're going to have this equilibrium right here. We're going to have this equilibrium at this price level, p 1 and GDP 1. Okay?

And then, like I said, in the dynamic model, everything's going to shift to the right. So we're going to shift our aggregate demand to the right. We're going to shift our aggregate supply to the right. So this is AD 2 now. Shift short-run aggregate supply to the right. And guess what else is shifting to the right? Our long-run aggregate supply. So there's short-run aggregate supply too. And finally, long-run aggregate supply. So we've got a lot of curves going on here now. But notice, it's just our same star shape equilibrium. It's just shifted to the right. Everything is just shifted to the right there. And what I've tried to do because what generally happens in an expansion here so let me label this long-run aggregate supply 2. So it definitely helps to have multiple colors. Everything's shifted to the right. All that we have is our new equilibrium at a higher GDP, GDP 2. And if I had done this right, it's approximately the same price level because everything has expanded here. If our aggregate demand, our aggregate supply, and our long-run aggregate supply have all expanded to lead to this higher potential GDP, a higher long-run equilibrium. And we keep that same general price level, at that new equilibrium. Cool? So this is a very standard case of what happens. In future videos, we'll see what happens during recessions and during inflation as well. And how fiscal policy, monetary policy, what we can also discuss what all those components have to do with the dynamic model as well. Alright? So for now, we'll, we'll keep it here and this is just the general thing that happens. Year over year, everything shifts to the right. Cool? Alright. Let's go ahead and pause and move on to the next video.

Here’s what students ask on this topic:

What is the dynamic AD-AS model in macroeconomics?

The dynamic AD-AS model is an extension of the standard aggregate demand and aggregate supply framework. It accounts for economic growth over time by allowing both the long-run and short-run aggregate supply curves to shift rightward annually. This shift is due to factors such as technological advancements, increases in the labor force, and population growth. Aggregate demand also increases over time, driven by higher consumption, investment, and government spending. This model results in a new equilibrium with a higher potential GDP while maintaining a stable price level, illustrating the continuous expansion of the economy.

How does the dynamic AD-AS model differ from the standard AD-AS model?

The dynamic AD-AS model differs from the standard AD-AS model by incorporating economic growth over time. In the standard model, long-run aggregate supply (LRAS) is held constant, assuming no long-term inflation or growth in potential GDP. In contrast, the dynamic model shifts both the long-run and short-run aggregate supply curves to the right annually, reflecting technological advancements, population growth, and other factors. Aggregate demand also increases yearly, driven by higher consumption, investment, and government spending. This results in a new equilibrium with a higher potential GDP and a stable price level, better reflecting real-world economic conditions.

Why do the aggregate supply curves shift to the right in the dynamic AD-AS model?

In the dynamic AD-AS model, both the long-run and short-run aggregate supply curves shift to the right annually due to several factors. These include technological advancements, which improve productivity; increases in the labor force, which provide more workers; and population growth, which expands the market. Additionally, the construction of new factories and infrastructure contributes to higher potential GDP. These shifts reflect the continuous growth and expansion of the economy, leading to a higher potential GDP over time.

What factors contribute to the increase in aggregate demand in the dynamic AD-AS model?

In the dynamic AD-AS model, aggregate demand increases over time due to several factors. Higher consumption results from rising incomes and population growth. Increased investment occurs as firms expand their businesses in a growing economy. Government spending also rises to meet the needs of a larger population and a more complex economy. These factors collectively drive the aggregate demand curve to shift to the right annually, contributing to the overall economic growth depicted in the dynamic model.

How does the dynamic AD-AS model explain economic expansions?

The dynamic AD-AS model explains economic expansions by showing how both aggregate supply and aggregate demand curves shift to the right over time. This rightward shift is due to factors such as technological advancements, population growth, and increased investment and consumption. As a result, the economy reaches a new equilibrium with a higher potential GDP while maintaining a stable price level. This continuous rightward shift of the curves illustrates the ongoing expansion of the economy, reflecting real-world economic growth more accurately than the standard AD-AS model.