AD-AS Model: Recession and Overheating - YouTube

This video is for students of economics and it's about the AD-AS (aggregate demand and aggregate supply) model,

and about how to show the real-lief economy on the graph.

The AD-AS model is confusing and complicated, but here, I'll make it simple and easy for you.

In this video, you can learn the AD-AS model in detail, but if you don't have time, let me teach you the model in just 2 minutes.

Do you remember the supply-and-demand model? Price and quantity, supply and demand.

We are going to apply the S&D model of one product

to all goods and services produced in the economy.

Supply of one product becomes aggregate supply

and demand of one product becomes aggregate demand

And the AD-AS model will look like this:

On the vertical axis, we put the general price level

It's the average price for all goods and services produced

For example, CPI or GDP deflator

And on the horizontal axis, we put GDP

The AD curve looks like a traditional demand. It's a downward-sloping curve.

Next, aggregate supply

Here, we'll have not one but two AS curves

The long-run AS and the short-run AS

The short-run aggregate supply looks like a normal supply, upward-sloping curve

And the long-run aggregate supply is a vertical line, fixed at potential output

(potential output is GDP produced at full employment)

And when all curves intersect, that intersection is called the long-run equilibrium.

At the long-run equilibrium, the economy is normal, stable, and steady

But the real-life economy is often abnormal and unstable

Remember the year 2020?

The pandemic, economic meltdown, and all-time high unemployment.

Can we say that in 2020, the economy was normal and stable? No.

No, the economy wasn't in the long-run equilibrium.

The economy was in a severe recession.

How to show a recession on the graph?

First, draw the LRAS.

Where's the economy? Is it on the right or on the left?

The economy in a recession is on the left.

It produces less than potential output

The difference between the current GDP is potential output is called a recessionary gap.

What about the opposite situation, an overheating economy?

For example, after 2020, economies started to recover, and they were recovering so fast that there was a danger of overheating economy

How to show an overheating economy on the graph?

An overheating economy is on the right of LRAS.

It produces more than potential output.

The difference between the current GDP and potential GDP is called an inflationary gap.

You are a student, and you'll have a test.

And that test will have a problem on AD-AS.

And that problem will have one out of three possible situations:

The long-run equilibrium, or a recession, or an overheating economy.

3 economies, 3 graphs

Watch my next videos to see how to solve problems on AD-AS