Jason Smith — What does the AD-AS model mean?

Cameron Murray has a new post up about logical fallacies and contradictions involved in setting up the AD-AS model in macroeconomics. I personally like the AD-AS model as a toy model of how an economy works. It misses out on a bunch of details, but I think it forms a fine basis from which to depart with more detailed model.

The focus of the Murray's post is the fallacy of composition, which I've seen used as a rhetorical device in many instances (the sum of government spending effects on local spending doesn't mean there is an aggregate effect, or prudent increased saving by individuals isn't prudent for the overall economic situation in the paradox of thrift). As a physicist, I've always thought of it as a strange rhetorical device. In physics we have large numbers of examples where the fallacy applies, but it is never used. I think the reason it is never used is that in general there is a specific effect at work and we'd refer to that effect instead of the "fallacy of composition" -- quark confinement, entropic forces, emergent dimensions in string theory, pretty much all of materials science.
I think the fallacy of composition would better be called the warning of composition -- an idea that warns you of:

• Effects that might go away at the macro scale (an example is the SMD theorem, and on this blog most of the details of how economic agents operate)

• Effects that might not exist at the micro scale, but do at the macro scale ("entropic forces", emergent properties, and on this blog nominal rigidity)

The warning of composition can help prevent you from making unwarranted jumps in logic. But sometimes those jumps are warranted (or you have explicit machinery for adding the effects together).

So let's look at the AD-AS model in the information equilibrium framework. It essentially lives entirely on the macro scale, so there isn't any fallacy of composition. We instead have failures of information equilibrium, exceptions and other micro effects.

Jason Smith is a physicist whose hobby is economic theory and modeling.

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What does the AD-AS model mean?
Jason Smith