Previous studies have shown that activated cortical states (awake and rapid eye-movement (REM) sleep), are associated with increased cholinergic input into the cerebral cortex. However, the mechanisms that underlie the detailed dynamics of the cortical transition from slow-wave to REM sleep have not been quantitatively modeled. How does the sequence of abrupt changes in the cortical dynamics (as detected in the electrocorticogram) result from the more gradual change in subcortical cholinergic input? We compare the output from a continuum model of cortical neuronal dynamics with experimentally-derived rat electrocorticogram data. The output from the computer model was consistent with experimental observations. In slow-wave sleep, 0.5–2-Hz oscillations arise from the cortex jumping between “up” and “down” states on the stationary-state manifold. As cholinergic input increases, the upper state undergoes a bifurcation to an 8-Hz oscillation. The coexistence of both oscillations is similar to that found in the intermediate stage of sleep of the rat. Further cholinergic input moves the trajectory to a point where the lower part of the manifold in not available, and thus the slow oscillation abruptly ceases (REM sleep). The model provides a natural basis to explain neuromodulator-induced changes in cortical activity, and indicates that a cortical phase change, rather than a brainstem “flip-flop”, may describe the transition from slow-wave sleep to REM.