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Dynamic AD/AS Model

Dynamic AD-AS Model: Introduction

IMPORTANT:Many professors ignore the dynamic AD-AS model in an introductory economics class. Double check with your class notes before you spend time on these videos!



Dynamic AD-AS Model: Introduction

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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 A. D. A. S. Model that a lot of professors skip this altogether. They focus on just the regular A. D. A. S. 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 gonna need to know this and if not easy peasy just skip right over it. Alright, so let's go ahead here. The dynamic A. D. A. S. Model. So remember when we do the A. D. A. S. 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 equilibrium etcetera. So we studied that standard A. D. A. S. Model. We made some assumptions there was no long run inflation. We were always holding this L R A L R A. S. The long run model, long run aggregate supply, we're 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 um what it usually shows us when we were doing our analysis is that a recession caused by decreased aggregate demand. So we would be shifting it would be a recession and we would be shifting aggregate demand 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 one and price to write 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 19 thirties. So what we do in the dynamic A. D. A. S. Model is we try and remove those assumptions where we have that static potential GDP, that long run aggregate supply. So what we're gonna do is we're gonna try and fix this by actually shifting the curves to uh to compensate for growth in the economy, we're actually gonna 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, it increases over time. Over time we have new technology, we have increases in the labor force, there's more population, there's more uh factories built, there's just more stuff. So our potential GDP is growing over time? So the dynamic 80 S. A. D. A. S. Model long run aggregate supply shifts to the right yearly. So we're gonna be shifting the aggregate uh the long run aggregate supply to the right this is because it's increasing and just like long run aggregate supply is increasing while 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 gonna see these shifts happening in these curves from one year to the next. We're gonna 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, 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 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 gonna be shifting all the curves to the right to a new equilibrium in the 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 ds long run aggregate supply and short run aggregate supply. So I'm gonna label these all one. Actually gonna 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 one. Short run aggregate supply one. And aggregate demand one. Okay. And then we're gonna have this equilibrium right here, we're gonna have this equilibrium at this price level P. One and G. D. P. One. Okay. And then like I said in the dynamic model, everything's gonna shift to the right so we're gonna shift our aggregate demand to the right, we're gonna shift our aggregate supply to the right, so this is a D. Two. 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 two 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 shaped equilibrium, it's just shifted to the right, everything's 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 too, 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 too. And if I had done this right, it's approximately the same price level because everything has expanded here are aggregate demand and aggregate supply and our long run aggregate supply has all expanded um to lead to this higher potential GDP a higher long run equilibrium and we keep the same general price level um at that 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 will we can also discuss what all those components have to do with the dynamic model as well. Alright, so for now we'll uh 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