Short on time? This page is the recap. For explanations, graphs and worked examples, use the full study guide.
Recap
- A shock shifts AD or SRAS. Positive = right, negative = left. In the short run, LRAS does not move.
- Spending changes (C, I, G, NX) shift AD. Cost changes (wages, input prices, expected inflation, productivity, supply shocks) shift SRAS.
- AD shock: the price level, real output and employment move in the same direction.
- SRAS shock: output and employment move one way, the price level the other way.
- Demand-pull inflation: AD shifts right. Cost-push inflation: SRAS shifts left.
- Stagflation: a higher price level with lower output and higher unemployment, after a negative SRAS shock.
- After an AD shift, output changes by less than the horizontal shift, because the price level also changes.
Key relationships
| Shock | Price level | Real output | Employment | Unemployment |
|---|---|---|---|---|
| AD ↑ (positive) | ↑ | ↑ | ↑ | ↓ |
| AD ↓ (negative) | ↓ | ↓ | ↓ | ↑ |
| SRAS ↑ (positive) | ↓ | ↑ | ↑ | ↓ |
| SRAS ↓ (negative) | ↑ | ↓ | ↓ | ↑ |
| Quantity | Formula |
|---|---|
| Size of AD shift from a spending change | spending change × 1 ÷ (1 − MPC) |
| Inflation rate | (PL₂ − PL₁) ÷ PL₁ × 100 |
Assumptions
- Short run only: nominal wages are sticky and LRAS is fixed.
- One curve shifts at a time unless the question says otherwise.
- What happens after the short run, with no policy, is Topic 3.7.
Mistakes to avoid
- Shifting a curve because the price level changed. That is a movement along it.
- Treating an energy price rise as an AD shift. It raises costs: SRAS left.
- Calling every price rise demand-pull. Check whether output rose or fell.
- Saying output rises by the full AD shift.
- Moving LRAS for a temporary cost shock.
- Saying unemployment and the price level always move in opposite directions. Not after a negative SRAS shock.
- Leaving out the old curve or the new equilibrium labels on a graph.
Quick self-check
VD is the valda, the currency of the fictional country Valdoria used in the study guide.
- After a shock the price level rises from 104 to 108 and real GDP falls. Which shock, and what type of inflation? (SRAS decreased; cost-push, 3.85%)
- Government spending rises by VD 10 billion and the MPC is 0.8. How far does AD shift, and does output rise by more or less than this? (VD 50 billion; less)
- Productivity rises across the economy. What happens to unemployment in the short run? (It falls: SRAS shifts right and output rises)
Next: practice questions.