01 / 21

Changes in the
AD-AS Model

Explore how aggregate demand and aggregate supply shifts create real economic outcomes: changes in output, price level, and employment in the short run.

AP Macroeconomics

What Is the AD-AS Model?

The Aggregate Demand / Aggregate Supply model is the primary framework economists use to analyze macroeconomic fluctuations. It shows how the overall price level and real GDP are determined by the interaction of total spending (AD) and total production (AS) in an economy.

AD: Aggregate Demand
Total spending on domestic goods and services at each price level: \( AD = C + I + G + (X - M) \)
SRAS: Short-Run AS
Total output firms produce at each price level when input prices are sticky
LRAS: Long-Run AS
Full-employment output level: vertical at potential GDP (\( Y_f \))

The Basic AD-AS Diagram

Price Level (PL) Real GDP (Y) LRAS SRAS AD PL₁ Y₁
\( Y_f \)

Why Do Curves Shift?

A movement along a curve happens when the price level changes. A shift of the entire curve happens when a non-price-level determinant changes. In macroeconomics, identifying which curve shifts and which direction is the core analytical skill.

AD Shifters
Consumer confidence, government spending, taxes, investment, net exports, money supply
SRAS Shifters
Input prices (wages, oil), productivity, business taxes and subsidies, supply shocks

Increase in Aggregate Demand

PL Real GDP SRAS AD₁ AD₂ PL₁ Y₁ PL₂ Y₂

Decrease in Aggregate Demand

PL Real GDP SRAS AD₁ AD₂ PL₁ Y₁ PL₂ Y₂

Negative Supply Shock: SRAS Decreases

PL Real GDP AD SRAS₁ SRAS₂ PL₁ Y₁ PL₂ Y₂

Positive Supply Shock: SRAS Increases

PL Real GDP AD SRAS₁ SRAS₂ PL₁ Y₁ PL₂ Y₂

Demand-Pull vs. Cost-Push Inflation

Demand-Pull Cost-Push
Which curve shifts? AD shifts right SRAS shifts left
Price level Rises Rises
Real GDP Rises Falls
Unemployment Falls Rises
Example cause Tax cut, increased G Oil price spike, wage increase
Policy dilemma? No: contractionary is clear Yes: stagflation trap

Understanding Output Gaps

Recessionary Gap
Actual output is less than potential output (\( Y < Y_f \)). Unemployment is above the natural rate. Economy operates below capacity.
Inflationary Gap
Actual output is greater than potential output (\( Y > Y_f \)). Unemployment is below the natural rate. Economy overheats, prices rise.

How to Analyze an AD-AS Shift

1
Identify the event. Read the scenario and determine what changed: a spending-side factor or a production-cost factor.
2
Pick the curve. Spending changes shift AD. Cost/productivity changes shift SRAS.
3
Choose the direction. Positive events shift the curve right. Negative events shift it left.
4
Find the new equilibrium. Trace where the shifted curve intersects the other curve. Read off the new PL and Y.
5
State the effects. Report changes in price level, real GDP, and unemployment. Identify any output gap created.

Example 1: Government Increases Spending

Scenario: Congress passes a large infrastructure bill, increasing government spending (\( G \)) by $500 billion.

1
Event: Government spending (\( G \)) increases: a spending-side change.
2
Curve: AD shifts right because \( G \) is a component of AD.
3
Effects: PL rises (inflation), Real GDP rises, unemployment falls.
4
Gap: If the economy was at \( Y_f \), this creates an inflationary gap.

Example 2: Oil Prices Surge

Scenario: A geopolitical conflict disrupts global oil supply, causing energy prices to double.

PL Real GDP AD SRAS₁ SRAS₂ PL₁ Y₁ PL₂ Y₂

Example 3: Simultaneous Shifts

Scenario: The central bank cuts interest rates (increasing AD) at the same time that new technology reduces production costs (increasing SRAS).

AD shifts right
Lower interest rates boost investment (\( I \)) and consumption (\( C \)). More spending at every price level.
SRAS shifts right
Technology lowers per-unit production costs. Firms can produce more at every price level.

Common Mistakes to Avoid

Shifting the Wrong Curve
A change in consumer confidence shifts AD, not SRAS. A change in oil prices shifts SRAS, not AD. Always ask: spending or production?
Confusing Movement vs. Shift
A price level change causes movement along a curve. Only non-price determinants cause the entire curve to shift.
Forgetting Indeterminate Effects
When both AD and SRAS shift, one variable (PL or GDP) is usually indeterminate without knowing relative magnitudes.

Summary of Short-Run AD-AS Changes

Shift Price Level Real GDP Unemployment
AD increases (right) Rises Rises Falls
AD decreases (left) Falls Falls Rises
SRAS increases (right) Falls Rises Falls
SRAS decreases (left) Rises Falls Rises

Question 1 of 5

If consumer confidence increases, which curve shifts and in which direction?

Question 2 of 5

An economy experiences rising prices and falling real GDP. This is most likely caused by:

Question 3 of 5

If the government raises taxes on households, the most likely short-run effect is:

Question 4 of 5

If both AD and SRAS increase simultaneously, what can we say with certainty about the short-run effects?

Question 5 of 5

An economy is currently producing above its full-employment output (\( Y > Y_f \)). This situation describes: