Recently, the aggregate demand and aggregate supply model has been criticized by some economists for being used incorrectly to explain the macroeconomic model; Barro and Geithman (1994). The authors of this study, Lila J. Truett and Dale B. Truett (1998), argue that the usefulness of the aggregate demand (AD) and aggregate supply (AS) model can be better explained if the AD is defined consistent with the ISLM model and the AS is defined consistent with the equilibrium in factor markets. When these definition are used, it is useful to show the fundamental differences of classical and Keynesian perspectives. The aggregate demand is defined as the relationship between the real quantity demanded for the final goods and services and the price level. The AD curve represents the set of coordinate points that represent equilibrium point in the Keynesian-cross model. The downward slope of the AD curve has been justified by the real balance effect and the interest rate effect. The real balance effect occurs because a decrease in the general price level increases the real wealth of people owning financial assets (loans, stocks, bond, and etc). The interest rate effect occurs because as prices fall, the quantity supplied of money in real term excess the quantity demanded. This leads to a fall in the interest rate and a rise in quantity demand of consumption and investment. The aggregate supply is defined as the relationship between the real quantity supply of final goods and services and the general price level. Underpinning this definition of AS is the assumption that relative input costs and output prices are adjusted so that no excess supply or demand for factor of production at any point on AS curve. So AS curve is the factor-market equilibrium curve. The long run AS curve may be argue to be upward slope due to the real balance effect. As price rise, the real wealth of financial assets falls, so the people who hold those assets are willing to work more. The reverse effect occurs when price fall, people are willing to work less due to increasing in their wealth.
*American Economist, Spring 1998 v42, pp. 71-75.