Module 19
April 2015
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In the AD-AS Model, the aggregate supply
curve and the aggregate demand curve are
used together to analyze economic
fluctuations
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The economy is in short-run macroeconomic
equilibrium when the quantity of aggregate
output supplied is equal to the quantity
demanded
Short-run equilibrium aggregate price level is
the aggregate price level in the short-run
macroeconomic equilibrium
Short-run equilibrium aggregate output is the
quantity of aggregate output produced in the
short-run macroeconomic equilibrium
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Demand shock – events that shift the
aggregate demand curve (Great Depression
was a negative demand shock fixed by WWII
government spending which was a positive
demand shock).
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Supply shock – an event that shifts the shortrun aggregate supply curve
Negative supply shock raises production
costs and reduces quantity produced – oil
crises of 1973 and 1979
Positive supply shock reduces production
costs and increase quantity supplied –
Internet and new technology between 19952000
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Stagflation – the combination of inflation and
stagnating (or falling) aggregate output
Leads to rising unemployment
Supply shocks - cause the aggregate price
level and aggregate output to move in the
opposite directions
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The economy is in long-run macroeconomic
equilibrium when the point of short-run
macroeconomic equilibrium is on the longrun aggregate supply curve
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Recessionary gap – when aggregate output is
below potential output
Corresponds to high unemployment
Early 1930s Germany
Causes the SRAS to shift gradually to the right
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Inflationary gap – when aggregate output is
above potential output
Output gap – 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
𝑂𝑢𝑡𝑝𝑢𝑡 𝑔𝑎𝑝 =
𝐴𝑐𝑡𝑢𝑎𝑙 𝑎𝑔𝑔𝑟𝑒𝑔𝑎𝑡𝑒 𝑜𝑢𝑡𝑝𝑢𝑡−𝑝𝑜𝑡𝑒𝑛𝑡𝑖𝑎𝑙 𝑜𝑢𝑡𝑝𝑢𝑡
𝑝𝑜𝑡𝑒𝑛𝑡𝑖𝑎𝑙 𝑜𝑢𝑡𝑝𝑢𝑡
x 100
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1. Describe the short-run effects of each of
the following shocks on the aggregate price
level and on aggregate output.
A. the government sharply increases the
minimum wage, raising the wages of many
workers.
B. solar energy firms launch a major program
of investment spending
C. congress raises taxes and cuts spending.
D. severe weather destroys crops around the
world
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2. A rise in productivity increases potential
output, but some worry that demand for the
additional output will be insufficient even in
the long run. How would you respond?
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1. Which of the following causes a negative
supply shock?
◦ I. a technological advance
◦ II. Increasing productivity
◦ III. An increase in oil prices
a. I only
b. II only
c. III only
d. I and III only
e. I, II, and III
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2. Which of the following causes a positive
demand shock?
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a. an increase in wealth
b. pessimistic consumer expectations
c. a decrease in government spending
D. an increase in taxes
E. an increase in the existing stock of capital
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During stagflation, what happens to the
aggregate price level and real GDP?
Aggregate Price Level
Real GDP
A. decreases
increases
B. decreases
decreases
C. increases
increases
D. increases
decreases
E. stays the same
stays the same
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Refer to the graph for questions 4 and 5
4. Which of the following statements is true if
this economy is operating 𝑃1 𝑎𝑛𝑑 𝑌1 ?
I. the level of aggregate output equals potential
output
II. It is in short-run macroeconomic equilibrium
III. It is in long-run macro equilibrium
A. I only
B. II only
C. III only
D. II and III
E. I and III
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5. The economy depicted in the graph is
experiencing a(n)
A. contractionary gap
B. recessionary gap
C. inflationary gap
D. demand gap
E. supply gap
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1. Refer to the other graph
A. is the economy in short-run
macroeconomic equilibrium? explain.
B. is the economy in long-run
macroeconomic equilibrium? Explain.
C. what type of gap exists in this economy?
D. calculate the size of the output gap.
E. what will happen to the size of the output
gap in the long run?