2.2.2a Movements along and shifts of AD/AS

A Change in the Price Level Moves You Along AD and AS; Anything Else Shifts the Curve

1. Both the aggregate demand (AD) and aggregate supply (AS) curves are drawn with the average price level on the vertical axis and real output (real GDP) on the horizontal axis.
2. A movement along the curve comes from a change in the price level.
3. A shift of the whole curve comes from a change in a non-price determinant, such as spending, costs or productive capacity.

Aggregate Demand Shifts When Planned Spending Changes

1. Aggregate demand is total planned spending in the economy: $AD=C+I+G+(X-M)$.
2. Higher C, I, G or net exports shift AD to the right.
3. Falls in these components shift AD to the left.
4. Changes in confidence, interest rates, income, taxation and the exchange rate move these components and so shift the whole AD curve.

Short-run AS Shifts When Firms' Costs Change

1. Short-run aggregate supply (SRAS) shifts when firms' costs of production change, such as wages, raw material and energy prices, and business taxes.
2. A rise in these costs shifts SRAS to the left; a fall shifts it to the right.
3. Higher productivity lowers unit costs and can shift SRAS to the right.

Long-run AS Reflects Productive Capacity, Not Costs

1. Long-run aggregate supply (LRAS) reflects the economy's productive capacity: the quantity and quality of its factors of production, technology, investment, education and skills, and regulation.
2. These long-run capacity factors are different from the short-run cost factors that shift SRAS.
3. Underlying (trend) economic growth is represented by a rightward shift in the long-run AS curve.

Say Which Curve Moves and Why

2.2.2b Macroeconomic equilibrium and shocks

Equilibrium Is Where AD Meets AS and Fixes Output and the Price Level

1. Macroeconomic equilibrium is where aggregate demand equals aggregate supply.
2. It sets the equilibrium level of real output and the price level.
3. By implication it also shapes the level of employment.

The AD/AS Diagram Runs on the Average Price Level and Real Output

1. The axes are the average price level on the vertical axis and real output on the horizontal axis.
2. A rightward AD shift raises output and the price level.
3. A rightward AS shift raises output and tends to lower the price level.

Tracing a Demand-side Shock, Step by Step

1. Start at equilibrium where AD1 crosses SRAS, giving an initial price level and level of output.
2. Suppose a fall in consumer and business confidence cuts C and I: this negative demand shock shifts AD left from AD1 to AD2.
3. At the old price level there is now excess supply, so firms cut output and prices, moving down along SRAS.
4. The new equilibrium has lower real output and a lower price level, so a negative demand shock brings recession, rising demand-deficient (cyclical) unemployment and easing inflation, as in the 2008 to 2009 downturn.

A Supply-side Shock Can Raise Prices and Cut Output at Once

1. Start again at equilibrium where AD crosses SRAS1.
2. Suppose a sharp rise in global energy prices raises firms' costs: this negative supply shock shifts SRAS left from SRAS1 to SRAS2.
3. With AD unchanged, the new equilibrium sits at a higher price level but lower real output.
4. This mix of rising prices and falling output is stagflation, seen in the UK after the 2022 energy price spike.

Every Shift Moves Output and the Price Level, so Read Both

1. Every shift changes both output and the price level.
2. Reading only one misses half the effect.
3. So trace both the output effect and the price effect from the diagram.

When AD and AS Shift at Once, Separate the Output and Price Effects

1. AD and AS can move at the same time.
2. The output effects may reinforce each other while the price effects offset.
3. So the net effect on output and prices depends on the relative size of the two shifts.