Colander, David. The Stories We

Colander, David. The stories we tell: A reconsideration of as/AD analysis.

The Journal of Economic Perspectives, 9.3 (1995, Summer): 169-188.

"The stories we tell: A reconsideration of as/AD analysis" may sound like a strange title for an article on economics education. But according to the author David Colander, every economic paradigm, every theoretical perspective is a 'story.' The first part of the conventional 'story' of the Aggregate Supply and Aggregate Demand Model (as/AD) that most undergraduates receive in economics class is as follows: the economy is roughly split into suppliers and consumers. As consumers demand more of a product, price increases. Suppliers attempt to capitalize upon that demand. Then, as consumers desire less of a good or a service, price decreases, as producers attempt to rid themselves of excess inventory and re-stimulate interest in their business. Equilibrium is achieved through the negotiation of these two opposing forces, and eventually an optimal level of price and demand is reached.

Although the model allows for some variation, such as the greater availability of substitutes for some goods and the greater elasticity of demand and supply for some items, it is a fairly simple model. But while it is teachable and intuitively makes sense to students, says Colander, it is also fundamentally flawed as a real-life portrait of how the economy functions at any point in time. Because of its radical simplification, the as/AD model is a pedagogical and analytical tool, not a slice of life as it is often presented in introductory classes.

The as/AD model is further problematized through its integration with the Keynesian macroeconomic model taught in conjunction with Marshall's partial equilibrium microeconomic model. Keynes's model is what Colander calls the "dynamic disequilibrium adjustment story -- the multiplier story. If aggregate expenditures exceed aggregate production, then production increases, which causes income to increase, which causes expenditures to increase, and so on.... This chase between expenditures and production occurs in declining amounts (since the marginal propensity to consume is less than one), which means that, eventually, an aggregate expenditures/production equilibrium is reached" (Colander 1995, p.165). Many of Keynes' presuppositions, such as the multiplier effect and the stickiness of wages are not part of the classical model of supply and demand. And students quickly pick up on the contradictions inherent in the attempt to blend the classical and Keynesian perspectives in the as/AD model taught in most introductory classes.

"I think most economists would agree that the underlying disequilibrium adjustment story that appropriately accompanies the as/AD model is not descriptive of the real world, but is simply a defensive story to maintain the logic of the as/AD model of the economy. If we honestly told students that these are the underlying stories behind the analysis, most of them would ask, 'Why are you teaching us this? This is not the way the economy works'" writes Colander (Colander 1995, p. 178). To illustrate his point, Colander begins with an example of how economics is usually introduced to students, followed by an analysis of the problems inherent to the model. Colander creates a hypothetical student who is perceptive enough to intuitively challenge as/AD contradictions.

The first problem Colander's hypothetical student perceives is how supply and demand curves seem to function differently. The as curve, for example, is based upon a different conception of the economy than the AD curve and the as curve is shown as having "three ranges: a Keynesian range in which the as curve is perfectly horizontal, a classical range in which the as curve is perfectly vertical, and an intermediate range in which the as curve is upward-sloping. In this combination as curve, the long-run/short-run distinction is generally dropped" although it is not in the AD curve (Colander 1995, pp. 173). All of this is quite confusing to the student

The AD curve is equally problematic. The demand curve is usually defined as the graphic representation of various goods and services that society will purchase at various price levels -- but Keynes does not hold all elements constant, as does the classical model of economics. The Keynesian multiplier effect is not accounted for in the AD curve. This holds that as "aggregate expenditures increased, it brought about a supply response from firms who increased output" (Colander 1995, pp. 174-175). Regarding both curves, even on an intuitive level, wages and prices are not perfectly flexible in the real economy, particularly in regards to decreases in price level. Deflation has not happened on a significant level since the 1930s, but both classical and Keynesian economic theories allow for considerably greater potential for prices to fall than seems likely in fact (Colander 1995, pp. 174-177).

The problem of how to teach introductory economics, according to Colander, is just as knotty as the problem posed by the as/AD curve itself. One solution, called the "pedagogy is dirty" solution, suggests that teachers simply assume that there is necessary simplification that must take place within the context of an undergraduate economics classroom, given the complexity of the material being taught (Colander 1995, p.179). However, learning an internally inconsistent model is more confusing for some students than learning a more complex model.

Another approach is to teach the models separately and 'banish' both into their respective categories of micro and macroeconomics (Colander 1995, p.180). Classical adherents say that 'macro' issues should not be part of a general principles class. Keynesian adherents advocate a return to stressing the Keynesian model alone. Colander states the Keynesian model over-emphasizes the impact and influence of fiscal policy in a way that is not coherent with today's economic realities (and thus shows his own bias in favor of the classical model).

Colander offers his own model to replace the current classical, Keynesian, or hybrid forms. In his model "the definition of the AD curve would be changed so that the AD curve would no longer be derived from the Keynesian AE/AP model. The shape of the AD curve would reflect only the direct effect of any combination of the Pigou effect, the Keynes effect, the international effect, and the intertemporal price level effect that one believes makes logical sense," without presupposing a multiplier effect (Colander 1995, p.180). "In such a specification there would be no general presumption that [fiscal] policies work, as there is in the Keynesian model, or do not work, as there is in the current classical model. Such discussions would be institutionally specific and open to discussion" (Colander 1995, p.181).