Q. Show the equations of the AS-AD model?

The equations of the AS-AD model

To précis the AS-AD model, we can have a glance at its equations. IS-LM model was "solved" by simultaneously solving below equations 

Y_D(Y, R) = Y

M_D(Y, R) = M_S

For Y and R. As M_S was exogenous, we had two equations and two unknown and system of equation could be solved. Solution was explained by IS-LM diagram. 

In AS-AD model, situation is slightly more complicated since MD now relies on three variables: Y, R and P. We can no longer solve 

Y_D(Y, R) = Y

M_D(Y, R, P) = M_S

For Y, R and P as we have three unknowns and only two equations. We need one more equation in AS-AD model. The third equation in AS-AD model comes from the production function and the labor market. We illustrated that L depends on P and as Y_Srelies on L, Y_S will depend on P. Equilibrium requires that their supply equals actual production which is Y_S (P) = Y. The three equations of AS-AD model are thus:

Y_D(Y, R) = Y

M_D(Y, R, P) = M_S

Y_S (P) = Y

These are to be solved for Y, R and P. Solution is explained in AS-AD diagram, where first two equations are summarized in AD curve Y_D (P) = Y.

Note how the three different versions of Keynesian model are related to the number of variables / equations. 

• In cross model, we have only one variable (Y) and an equation: Y_D(Y) = Y.
• In IS-LM model, we have two variables (Y and R) and two equations: Y_D(Y, R) = Y and M_D(Y, R, P) = MS.
• In the AS-AD model, we have three variables (Y, R, P) and three equations: Y_D(Y, R) = Y, M_D(Y, R, P) = M_Soch Y_S (P) = Y.