EC212 · LESSON 07 / 08

7. AD–AS and economic fluctuations

Output can fall because spending weakens or production costs rise. These causes imply different price movements and policy problems.

Understand

What is this lesson explaining?

Weaker demand shifts AD left. Along the original upward SRAS, P and Y both fall. Demand stimulus can restore output, but its size and timing matter.

Higher costs shift SRAS up or left. With unchanged AD, Y falls while P rises: weak activity with price pressure. Stimulating AD to support output raises P further in this model.

Demand shockAn external change in spending at each price levelSupply shockA change in costs or productive capacityY*Potential output, not the absolute physical maximum

See it on a graph

The graph is right here

Read the axes and original point first. Then change one value at a time and watch the curve or point move.

KEY MODEL

AD:P=180−0.1Y

SRAS:P=80+0.1Y

E₀ : Y=600, P=120E₁ : Y=500, P=130

AD₀AD₁SRAS₀SRAS₁Y*

Change autonomous spending: 0 price units added to the AD intercept Supply cost shock: 20 model units

Spending shifts AD; production costs shift SRAS. Short-run equilibrium is Y=500, P=130. Y*=650 is potential output; the short-run intersection need not lie on it.

Blue dashed: original · Solid: new state · E₀/A: original point · E₁/B: new point. Coincident points share a label; use the explanation to read each result.

A curve shifts when one of its non-axis conditions changes. An adjusting point on a fixed curve is movement along that curve, not a shift of it.

Quick check

NO TYPING

Consumer confidence falls with costs and policy unchanged. What is the standard short-run outcome?

Takeaway

Remember these two ideas

✓

With AD: P = 180 − 0.1Y and initial SRAS: P = 60 + 0.1Y, equilibrium is (Y,P) = (600,120).

Common mix-upA one-time price-level increase does not prove permanently high annual inflation; that requires the path of prices over time.

Assumptions and sources

Start from equilibrium and change one factor. SRAS slopes up and AD down; the long-run example holds Y* fixed.

EC212 tutoring outline: chapters 1–8 (local course outline)
Mankiw, Macroeconomics, 8th edition, chapter 10, sections 10-4 and 10-5; chapter 14, p. 400