Macroeconomics

1 4-3

Using the Model

Let’s now use the dynamic AD –AS model to analyze how the economy

responds to changes in the exogenous variables. The four exogenous variables in

the model are the natural level of output Y

−

t

, the supply shock 

u

t

, the demand

shock 

e

t

, and the central bank’s inflation target 

p

t

*. To keep things simple, we will

assume that the economy always begins in long-run equilibrium and is then sub-

ject to a change in one of the exogenous variables. We also assume that the other

exogenous variables are held constant.

Long-Run Growth

The economy’s natural level of output Y

−

t

changes over time because of pop-

ulation growth, capital accumulation, and technological progress, as discussed

in Chapters 7 and 8. Figure 14-5 illustrates the effect of an increase in Y

−

t

.

Because this variable affects both the dynamic aggregate demand curve and

the dynamic aggregate supply curve, both curves shift. In fact, they both shift

to the right by exactly the amount that Y

−

t

has increased.

C H A P T E R   1 4

A Dynamic Model of Aggregate Demand and Aggregate Supply

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