Aggregate Demand and Supply Analysis: A Story in the Wrong Language

Abstract

As Colander (1995) has reminded us, undergraduate teaching in economics is largely a matter of telling stories. We present highly simplified models to students and use them as a peg on which to hang our stories. The models are not just to show students that economics is an analytical subject. Their main purpose is to help students remember the major features of the stories we tell. Thus, in microeconomics it is usual to present a typical Marshallian picture of the market for a particular good, with the demand curve sloping downwards and the supply curve sloping upwards, and then use this to talk about what happens if there is a demand shock or a supply shock. For example, if the price of raw materials rises, the supply curve will shift upwards, prices will rise and the quantity sold will fall. The relative importance of each of these changes will depend on the slope of the demand curve. We know that the model is grossly oversimplified: that the competitive market it assumes may not exist in the industry in question and that part of the reaction may be a shift in advertising to try to change the slope of the demand curve. We know that strictly speaking it is a purely static model and if a shock moves the amount bought and sold away from equilibrium, the market may never reach a new equilibrium (for example, when the cobweb theorem holds) and so on. But the story and the model are consistent and capture what we think is usually important in the real world. There is widespread consensus that the model and related story is a useful teaching tool which is rarely misleading.