Cambridge A Level Economics: Aggregate Demand and Aggregate Supply analysis (9708) – Revision Notes

These notes condense section 4.3 (Aggregate Demand and Aggregate Supply analysis, outcomes 4.3.1 to 4.3.12) of the Cambridge International AS & A Level Economics 9708 syllabus for examination in 2026, 2027 and 2028. It is AS Level content, and A Level candidates need it as assumed knowledge for Papers 3 and 4. For full explanations and worked examples, read the study guide. Then test yourself with the practice questions. All figures here are invented for illustration.

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Definitions (4.3.1, 4.3.2, 4.3.6)

Term	Definition
Aggregate demand (AD)	Total planned spending on an economy’s output at each price level in a given period
Aggregate supply (AS)	Total planned output firms are willing and able to supply at each price level in a given period
Real output	The volume of goods and services produced, measured at constant prices
Price level	The average level of prices in the economy
Short run (SRAS)	A period in which some costs, especially wages, are fixed
Long run (LRAS)	A period in which all costs and factors can adjust

The AD identity (4.3.2)

AD = C + I + G + (X - M)

Symbol	Meaning
C	Consumption by households
I	Investment by firms in capital goods
G	Government spending on goods and services
X - M	Net exports: exports less imports

Reminder. Country D: C = 540, I = 150, G = 210, X = 180, M = 200. Net exports = -20. AD = 540 + 150 + 210 - 20 = 880.

Determinants of AD (4.3.3, 4.3.5)

Detailed knowledge of the components is not required. Remember the main causes and the component they act on.

Component	Causes of a change
C	Disposable income, interest rates, wealth, confidence, credit, income tax
I	Interest rates, expected profits, confidence, technology, business taxes
G	Government spending decisions
X	Foreign incomes, exchange rate, relative prices
M	Domestic incomes, exchange rate, relative prices

Any change in these at the same price level shifts AD. Higher spending shifts it right and lower spending shifts it left.

Why AD slopes downward (4.3.4)

A lower price level raises the real output demanded because of three effects:

• Wealth effect: the real value of savings rises, so households spend more.
• Interest rate effect: lower prices reduce the money needed for transactions, so interest rates tend to fall and borrowing rises.
• International trade effect: domestic goods become cheaper than foreign goods, so X rises and M falls.

Do not use the single-good substitution argument. The whole price level has fallen.

Determinants of AS (4.3.7)

• Price level (a movement along SRAS).
• Costs of production: wages, raw materials, energy, business taxes, subsidies, the exchange rate through imported inputs.
• Quantity and quality of factors of production.
• Technology and productivity.
• Institutions and regulation.

Shapes of SRAS and LRAS (4.3.8)

Curve	Shape	Reason
SRAS	Upward sloping line or sweeping curve	Higher prices with fixed wages raise profit margins and output
LRAS (option 1)	Vertical	Output set by capacity, not the price level
LRAS (option 2)	Three sections: highly elastic, upward sloping, vertical	Spare capacity, then bottlenecks, then full capacity

Both LRAS shapes are in the syllabus. State which one you are using, and say why.

Price
level |                  |
      |                  |  vertical: full capacity
      |                /
      |              /      upward sloping: bottlenecks
      |_____________/
      |  highly elastic: spare capacity
      +--------------------------- Real output

In the highly elastic section a rise in AD mostly raises output. In the upward section it raises both. In the vertical section it raises only the price level.

Shifts in SRAS and LRAS (4.3.9)

Curve	Right	Left
SRAS	Lower wages or raw material costs, lower business taxes, subsidy	Higher wages or energy costs, higher business taxes
LRAS	More or better labour and capital, new technology, better institutions	Fewer workers, lost capital or resources, weaker institutions

A cost change is mainly an SRAS shift. A change in capacity is an LRAS shift.

Movement versus shift (4.3.10)

Event	Movement or shift
Price level changes	Movement along AD and along SRAS
Any other determinant of AD changes	Shift of AD
Any other determinant of AS changes	Shift of SRAS or LRAS

A price change caused by one shift is a movement along the other curve, not a second shift.

Method in steps: analysing a change (4.3.11, 4.3.12)

1. Identify the event and the curve it affects (AD, SRAS or LRAS).
2. Decide the direction of the shift, right or left.
3. Draw (or describe) the new curve, labelling the axes price level and real output.
4. Read the new equilibrium and compare it with the old one.
5. State the changes in real output, the price level and employment.
6. Add one evaluation point: slope of SRAS, shape of LRAS, time lag or other shifts.

Effects of shifts (4.3.12)

Shift	Real output	Price level	Employment
AD right	Up	Up	Up
AD left	Down	Down	Down
SRAS right	Up	Down	Up
SRAS left	Down	Up	Down
LRAS right	Up	Down	Up

On the vertical section of a three-section LRAS, a rightward shift of AD raises only the price level.

Reminder. Country E: AD output = 1,200 - 3P and SRAS output = 300 + 6P. Equilibrium: 9P = 900, so P = 100 and output = 900. If AD output becomes 1,290 - 3P: 9P = 990, so P = 110 and output = 960. Output rises 6.7% and prices rise 10%.

Reminder. Country M: AD output = 1,000 - 2P and SRAS output = 400 + 4P give P = 100 and output = 800. If energy costs rise and SRAS output becomes 340 + 4P, then 6P = 660, so P = 110 and output = 780. Prices rise 10% and output falls 2.5%. Real output and employment fall while prices rise.

Equilibrium and disequilibrium (4.3.11)

• Equilibrium is where AD = AS: planned spending equals planned output.
• Above the equilibrium price level, AS exceeds AD, stocks build and prices and output fall.
• Below it, AD exceeds AS, stocks fall and prices rise.
• Employment follows output. Equilibrium need not be at full employment.

Must-know distinctions

• AD curve versus a market demand curve: AD uses the whole price level, with no substitution between goods.
• SRAS versus LRAS: costs shift SRAS, while capacity shifts LRAS.
• Movement versus shift: price level for movement, any other determinant for shift.
• Vertical LRAS versus three-section LRAS: capacity-only versus spare capacity in the early range.
• Real output versus price level: they are different axes, and a shift can raise one while lowering the other.

Evaluation prompts

• How steep is SRAS, and so how is the effect split between output and prices?
• Is there spare capacity, so is the economy on the flat or the steep section?
• How long do effects take, and are there lags?
• Which other curves move at the same time?
• Is LRAS best drawn as vertical, or as three sections?

Quick self-test

1. Define aggregate demand.
2. Country A: C = 300, I = 80, G = 110, X = 90, M = 120. Calculate AD.
3. State the component of AD that a fall in interest rates mainly affects.
4. Name the effect that explains why a lower price level raises net exports.
5. State whether a rise in wages shifts SRAS, LRAS or both in the short run.
6. A rise in the price level caused by a fall in SRAS is a shift or a movement along AD?
7. Give two shapes for the LRAS curve allowed in the syllabus.
8. AD output = 1,000 - 2P and SRAS output = 400 + 4P. Find equilibrium price level and output.
9. Describe the effect on real output, price level and employment of a rightward shift of SRAS.
10. On which section of a three-section LRAS does a rise in AD raise only the price level?

Answers

1. Total planned spending on an economy’s output at each price level in a given period.
2. 300 + 80 + 110 + (90 - 120) = 460.
3. Investment, and also consumption.
4. The international trade effect.
5. SRAS (a cost change). LRAS is unchanged.
6. A movement along AD.
7. Vertical; or three sections (highly elastic, upward sloping, vertical).
8. 1,000 - 2P = 400 + 4P, so 6P = 600, P = 100, output = 800.
9. Real output rises, the price level falls, and employment rises.
10. The vertical section.

Where marks are usually lost

• Labelling the axes “price” and “quantity” instead of “price level” and “real output”.
• Shifting AD when only the price level has changed.
• Using substitution to explain the slope of AD.
• Shifting LRAS for a cost change.
• Writing about output and prices but omitting employment when the question asks for all three.
• Stating a shift without saying which determinant caused it.
• Describing a result without naming the new equilibrium.
• Giving one-sided evaluation with no judgement.

Official syllabus

Cambridge International AS & A Level Economics 9708, syllabus for examination in 2026, 2027 and 2028, version 2, published by Cambridge University Press & Assessment. These notes cover section 4.3.