Macro ad/as model

Let us first understand the components of the AD/AS model, so we can determine and identify the factors which play a part in the level of output in the economy, and learn how the government intervenes in order to implement macro-policies in order to increase output, and the effects of these policies on the economy. The AD/AS model shows the combinations of both the aggregate demand curve and the aggregate supply curve.

The aggregate demand curve shows the combinations of the price level and level of output at which both the money market and good market are in equilibrium, while the aggregate supply curve shows for each given price level the mount of out of output the firms are willing to supply. As mentioned in the 10th edition of macroeconomics by Mc Grawhill "the aggregate supply -aggregate demand model is the basic macroeconomic tool for studying output fluctuations" (Pg. 98, Macroeconomics, Rudiger Dornbush).

Let us first understand the market equilibrium price of the product and then identify and analyze how factors such as change in demand and supply, elasticity, separating and pooling equilibrium, market structure determine the price of a good or service. In free market, equilibrium price is the price at which there is no surplus or shortage nd therefore quantity demanded equals quantity supplied (Sloman 2008). At equilibrium, any change in quantity demanded or quantity supplied will move the market towards disequilibrium Let's work through an example.

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For this example, refer to . Notice that we begin at point A where short-run aggregate supply curve 1 meets the long-run aggregate supply curve and aggregate demand curve 1 . The point where the short-run aggregate supply curve and the aggregate demand curve meet is always the short-run equilibrium. The point where the long-run aggregate supply urve and the aggregate demand curve meet is always the long-run equilibrium. Thus, we are in long-run equilibrium to begin. Now say that the Fed pursues expansionary monetary policy.

In this case, the aggregate demand curve shifts to the right from aggregate demand curve 1 to aggregate demand curve 2. The intersection of short- run aggregate supply curve 1 and aggregate demand curve 2 has now shifted to the upper right from point A to point B. At point B, both output and the price level have increased. This is the new short-run equilibrium. But, as we move to the long run, the expected price level comes into line with the ctual price level as firms, producers, and workers adjust their expectations.

When this occurs, the short-run aggregate supply curve shifts along the aggregate demand curve until the long-run aggregate supply curve, the short-run aggregate supply curve, and the aggregate demand curve all intersect. This is represented by point C and is the new equilibrium where short-run aggregate supply curve 2 equals the long-run aggregate supply curve and aggregate demand curve 2. Thus, expansionary policy causes output and the price level to increase in the short run, but only the price level to increase in the long run

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