Posted by: Dirk | May 10, 2007

AS/AD Analysis – a flawed model

That the AS/AD model is flawed is common knowledge among Economists, but still I found it quite hard to find the right paper to read why. Now I would recommend a paper by David Colander entitled “The Stories We Tell: A Reconsideration of AS/AD Analysis“. The main points are:

1) The AS/AD model is inconsistent with respect to supply. The AD curve comes out of the IS/LM model and therefore some assumptions about demand are already included (like the multiplicator). Hence the AS curve, which also has rules on supply, should be consistent with the rules from the IS/LM model. It is not.

2) There are various problems with the dynamics. To name just one: a contraction of demand (left shidt of the AD curve) triggers a fall of the price level. This does not happen in the real economy, and if it happens, it’s probably another Great Depression (oh no!). So Economists do not believe in that kind of dynamics.

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