 1929-1933 the U.S. economy moved down the
short-run aggregate supply curve as the
aggregate price level fell
 1979-1980, the U.S. economy moved up the
aggregate demand curve as the aggregate price
level rose
 Both cases, a movement occurred
 The AS-AD model uses the aggregate supply
curve and the aggregate demand curve
together to analyze economic fluctuations.
Short-run macroeconomic equilibrium is the
point at when the quantity of aggregate output
supplied is equal to the quantity demanded by
domestic households, businesses, the
government and the rest of the world
Short-run
equilibrium
aggregate price
level ESRPE is the
aggregate price
level in the shortShort-run equilibrium aggregate
run
output ESRYE is the quantity of
macroeconomic
aggregate output produced in the
equilibrium
short-run macroeconomic equilibrium
 When there is a shortage of any individual good, it
causes the market to price to rise
 When there is a surplus, the good causes its
market price to fall
 Both ensures that the market reaches equilibrium
 Same for short-run macroeconomic equilibrium
 Aggregate price level is above it equilibrium level,
the quantity of aggregate output supplied exceeds
the quantity of aggregate output demanded
 Leads to a fall in the aggregate price level and
pushes it toward equilibrium
 The short-run equilibrium aggregate output
and the short-run equilibrium aggregate price
level can change because of shifts of either the
AD curve or the SRA curve
 Demand Shock
 An event that shifts the aggregate demand curve
 Change in expectations or wealth
 Effect of the size of the existing stock of physical
capital
 Use of fiscal or monetary policy
 Great Depression was caused by a negative
demand shock – the collapse of wealth and of
business and consumer confidence that followed
the stock market crash
 The Depression was ended by a positive demand
shock – huge increase in government purchases
during WWII
 2008 – negative demand shock caused by the
housing market’s boom to bust
Demand shocks cause
aggregate output and the
aggregate price level to
move in the same direction
Stagflation is the combination of inflation and
falling aggregate output. “Stagnation plus
inflation”
 Stagflation effects on the economy:
 Falling aggregate output leads to rising
unemployment
 Purchasing power is limited by rising prices
 Stagflation was present in the 1970s
•1990s – positive supply shock which led to full
employment and declining inflation
•Aggregate price level fell compared with the longrun trend
 Distinctive feature:
 They both cause aggregate price level and
aggregate output to move in OPPOSITE
directions
 Important contrast between both:
 Monetary policy and fiscal policy enable the
government to shift the AD curve
 Government is able to create shocks
 A supply shock is an event that shifts the SRAS
curve
 NEGATIVE SHOCKS
 Raise production costs and reduces the quantity
producers are willing to supply at any aggregate
price level (leftward shift)
 POSITIVE SHOCKS
 Reduce production costs and increase quantity
supplied at any given aggregate price (rightward
shift)
 The economy is in long-run macroeconomic
equilibrium when the point of short-run
macroeconomic equilibrium is on the long-run
aggregate supply curve.
Recessionary Gap is when aggregate output is below
potential output. Recessionary gap inflicts pain
because it corresponds with high unemployment.
Inflationary Gap is when aggregate output is above
potential output. Inflationary gap also causes low
unemployment, nominal wages will rise, as well as
sticky prices.
 There is a recessionary gap when aggregate output
is below potential output.
 There is an inflationary gap when aggregate
output is above potential output.
 The output gap is the percentage difference
between actual aggregate output and potential
output.
 The economy is self-correcting when shocks to
aggregate demand affect aggregate output in the
short run, but not the long run.