Aggregate Demand and Supply

Aggregate Demand and Supply Model and the Business Cycle

Showing Phases of the Business Cycle on the Keynesian AD/AS Model

Showing a Trough

A trough is a period where the level of economic activity is the lowest and the output gap between actual and potential output is the largest.

This can be shown in the AD/AS model with the placement of the AD line close towards the left side of the Aggregate Supply Curve. This is because it shows the low level of economic activity represented by the low figure of real GDP at Y1.

The important part is that this position of the AD/AS model shows the effect of increasing one or more components of aggregate demand, that is increases in AD will have a significant effect on real GDP but little effect on price levels as the economy still has unemployed resources.

Showing a Boom

A boom is a period where the level of economic activity is the highest and there is no output gap - that is the economy is operating at full capacity at potential output.

This is shown in the AD/AS model with the aggregate demand curve shown towards the right side of the AS curve. This shows a boom as it shows real GDP at Y1 is at a high level, representing high levels of economic activity.

Importantly, the Keynesian AD/AS model shows the effect of increasing one or more components of aggregate demand, that is, increasing AD will mainly result in increasing price levels and little or no impact on real GDP levels. 

Showing Upswings and Downturns

Upswings can be shown in the AD/AS model as a gradual shift in the AD curve from a trough position to a boom position. Vice versa, downturns are shown as a gradual decline from an AD boom position towards a trough.