Theory-Based Models
Theory-Based Models
A compact aggregate-demand and aggregate-supply view for separating demand shocks, cost shocks, and long-run capacity.
Variables
Aggregate real output.
Aggregate price level.
Capacity or potential output.
Assumptions
Short-run supply responds gradually, not infinitely fast.
That gives the diagram its upward-sloping SRAS schedule.
Potential output anchors the long run.
The long-run benchmark is capacity, not the current demand position.
Parameters
Demand strength at a zero price level.
How quickly demand falls as prices rise.
Baseline cost pressure at zero output.
How quickly marginal costs rise as output expands.
Long-run capacity or sustainable output.
Shock presets
Shifts AD outward.
Raises the SRAS intercept and worsens the tradeoff.
Raises potential output.