ABSTRACT
The AS-AD model is a complete macroeconomic model. It describes a general equilibrium involving the product market, the money market, the bond market, and the labor market. The AS-AD model generates an important distinction between the short-run and long-run behavior of the economy. In the short run, price expectations have been decided and are not subject to revision. Each period is a short run. The long run is defined as a state of the world in which all the markets are fully adjusted and price expectations are also fully adjusted. We will see that the long-run equilibrium of the AS-AD model is the natural level of GDP and the natural rate of unemployment. When the model is out of its long-run equilibrium (assuming one exists), it moves toward it through a sequence of short-run equilibria. The main dynamic factor that propels it is the cycle of price expectations, wage setting, and price setting that we studied in the previous chapter.
