The aggregate demand and aggregate supply (ADAS) model is a foundational tool in macroeconomics for analyzing short-term economic fluctuations. However, it has limitations when applied to real-world economies, especially over the long term. One key issue is that the traditional ADAS model assumes no long-run inflation and no long-run economic growth, which contradicts observed economic behavior. Inflation is a common feature in most economies, and economies typically experience growth over time. Consequently, the model’s prediction that the economy returns to the same equilibrium point on the long-run aggregate supply (LRAS) curve is unrealistic, as real economies evolve rather than cycle back to identical states.
Another significant flaw in the ADAS model is its explanation of recessions. The model suggests that recessions often begin with a decrease in aggregate demand, which should lead to a lower consumer price index (CPI). However, historical data, such as from the United States, show that recessions rarely coincide with falling prices, making this prediction inaccurate. This discrepancy highlights the need for a more flexible framework that better captures economic dynamics.
To address these shortcomings, the dynamic ADAS model introduces the concept of shifting curves over time, reflecting the evolving nature of the economy. In this model, the LRAS curve, which represents the economy’s potential GDP at full employment, shifts to the right as real GDP grows. This growth is driven by factors such as population increases and technological advancements, which enhance productive capacity.
Similarly, the short-run aggregate supply (SRAS) curve also shifts rightward over time due to the same underlying factors. As the economy’s capacity expands, the SRAS curve moves to reflect higher output levels at given price points.
The aggregate demand (AD) curve is expected to shift rightward as well, influenced by population growth that boosts consumption, increased business investment spurred by expanding economic opportunities, and higher government spending required to maintain public services for a larger population. These shifts collectively illustrate how the economy’s equilibrium evolves, often resulting in new equilibrium points with potentially different price levels and output.
While the dynamic ADAS model may sometimes show a new equilibrium with the same price level as before, this outcome depends on the relative rates at which the AD, SRAS, and LRAS curves shift. Variations in these rates can lead to diverse macroeconomic scenarios, including inflationary or recessionary pressures, underscoring the importance of understanding the interplay between aggregate demand and supply over time.
