Dynamic AD-AS Model

Dynamic AD-AS adds time and policy reaction to the static aggregate-demand and aggregate-supply diagram. Output and inflation are jointly determined by demand, supply, expectations, and the central bank's reaction rule.

The model is a bridge from textbook AD-AS to the New Keynesian three-equation system. It keeps the diagram readable while adding the idea that inflation expectations move over time.

Its core lesson is state dependence. The same shock can have different paths depending on expectations, policy credibility, and how quickly supply conditions normalize.

Dynamic aggregate demand slopes down in output-inflation space because higher inflation triggers tighter monetary conditions and lower demand.

Dynamic aggregate supply slopes up because higher output raises inflation pressure relative to expected inflation.

Expectations update shifts the supply curve over time. Demand shocks usually move output and inflation together; adverse supply shocks move them in opposite directions.

The model helps policy analysts distinguish demand inflation from supply inflation before choosing a rate path.

If the central bank satisfies the Taylor principle, expected real rates rise when inflation exceeds target, restraining demand.

If expectations become unanchored, the adjustment path can involve more inflation persistence and a higher output cost of disinflation.