Cambridge International AS and A Level Economics: Aggregate Demand and Aggregate Supply analysis (9708)

This guide covers 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. Topic 4 is AS Level content. A Level candidates study it too, and the syllabus treats AS content as assumed knowledge for A Level Papers 3 and 4. Every country, firm and figure below is invented for illustration. None is a real statistic.

Start from the Cambridge A Level Economics hub or the printable checklist. After this guide, use the revision notes and the practice questions. The macroeconomy practice set gives wider cover, and a free 10-minute diagnostic shows where you stand.

What this guide covers

Outcome	What you must be able to do
4.3.1	Define aggregate demand (AD)
4.3.2	Explain the components of AD: AD = C + I + G + (X - M)
4.3.3	Explain the determinants of AD (detailed knowledge of the components is not required)
4.3.4	Explain why the AD curve slopes downward
4.3.5	Explain the causes of a shift in AD
4.3.6	Define aggregate supply (AS)
4.3.7	Explain the determinants of AS
4.3.8	Describe SRAS (upward sloping line or sweeping curve) and LRAS (vertical, or three sections)
4.3.9	Explain the causes of a shift in SRAS and in LRAS
4.3.10	Distinguish a movement along from a shift in AD and AS
4.3.11	Show how equilibrium sets real output, the price level and employment
4.3.12	Analyse how shifts in AD and AS change real output, the price level and employment

The syllabus lists no formal calculation here, but the arithmetic below tests your diagrams.

4.3.1 and 4.3.2 Aggregate demand and its components

Aggregate demand is the total planned spending on an economy’s goods and services at each price level in a given period. The horizontal axis of an AD/AS diagram shows real output (real GDP). The vertical axis shows the average price level.

Symbol	Component	Meaning
C	Consumption	Household spending on goods and services
I	Investment	Firms’ spending on capital goods (machines, buildings)
G	Government spending	Government spending on goods and services, such as schools and roads
X	Exports	Foreign spending on the country’s output
M	Imports	Spending on foreign output, subtracted so AD counts only domestic output

X - M is net exports. If imports exceed exports it is negative and reduces AD.

Worked example 1: adding up AD

Country A (illustrative), in billion currency units (cu) for one year: C = 620, I = 180, G = 240, X = 210, M = 250.

• Net exports = 210 - 250 = -40.
• AD = 620 + 180 + 240 + (210 - 250) = 1,000.
• C is 620/1,000 = 62% of AD.
• If firms raise I by 20 with the price level unchanged, AD becomes 1,020, a rise of 20/1,000 = 2%. The AD curve has shifted right.

4.3.3 Determinants of AD

Anything that changes planned spending at a given price level changes AD. You need the main influences, not detailed theory.

• Consumption: disposable income, interest rates, wealth, confidence, availability of credit, income tax.
• Investment: interest rates, expected profits and business confidence, new technology, taxes on business profits.
• Government spending: decisions on public spending, which depend on policy choices.
• Exports: foreign incomes, the exchange rate, the price of the country’s goods relative to those abroad.
• Imports: domestic incomes, the exchange rate, relative prices.

4.3.4 Why the AD curve slopes downward

AD slopes down because a lower price level raises the quantity of real output demanded. Three standard reasons:

1. Wealth effect: a lower price level raises the real value of savings, so households spend more.
2. Interest rate effect: lower prices reduce the money needed for transactions, which tends to lower interest rates and raise borrowing for consumption and investment.
3. International trade effect: if domestic prices fall relative to foreign prices, exports rise and imports fall, so net exports rise.

This is not the market demand curve for one good. A single good’s curve slopes down partly because consumers switch to substitutes. In AD/AS the whole price level falls, so there is no “cheaper than everything else” substitution.

4.3.5 Causes of a shift in AD

A change in the price level moves you along the curve. A change in any other determinant of C, I, G or (X - M) at the same price level shifts the whole curve.

Shift	Examples
Right (AD up)	Fall in interest rates, rise in consumer confidence, rise in government spending, fall in income tax, rise in foreign incomes, depreciation of the currency
Left (AD down)	Rise in interest rates, fall in business confidence, cut in government spending, rise in income tax, fall in foreign incomes, appreciation of the currency

4.3.6 and 4.3.7 Aggregate supply and its determinants

Aggregate supply is the total planned output that all firms in an economy are willing and able to supply at each price level in a given period.

The price level is the reason for movements along the SRAS curve. These determinants shift it:

• Costs of production: wage rates, raw material and energy prices, business taxes, subsidies, the exchange rate (through imported inputs).
• Quantity and quality of factors of production: labour force size, skills, capital stock, land and resources.
• Technology and productivity.
• Institutions and regulation: the legal system, regulation, property rights.

4.3.8 The shapes of SRAS and LRAS

Short run (SRAS): the time period in which some costs, especially wages, are fixed. SRAS is an upward sloping line or sweeping curve. A higher price level with money wages fixed widens profit margins, so firms raise output.

Long run (LRAS): the time period in which all costs and factors can adjust. The syllabus allows two shapes.

• Vertical: output is set by the economy’s productive capacity, not by the price level.
• Three sections: highly elastic, then upward sloping, then vertical.

Price
level |                     |
      |                     |   <- vertical: capacity reached
      |                   /
      |                 /       <- upward sloping: bottlenecks
      |________________/
      |  highly elastic (spare capacity)
      +------------------------------ Real output

In the three-section curve, the first section reflects spare capacity (idle labour and machines, so extra output needs little price rise). The middle section reflects shortages in some industries. The last shows full capacity.

4.3.9 Causes of a shift in SRAS and LRAS

Curve	Shifts right	Shifts left
SRAS	Fall in wages or raw material costs, a business tax cut, a subsidy	Rise in wages, higher energy prices, a business tax rise
LRAS	More or better factors (more workers, more skills, more capital), better technology, better institutions	Fall in the labour force, loss of capital or resources, damage to institutions

An LRAS shift is a change in productive capacity. A change in costs usually shifts SRAS only.

4.3.10 Movement along versus shift

• A change in the price level moves the economy along AD and along SRAS.
• A change in any other determinant shifts the curve.

Watch the chain of effects. If SRAS shifts left, the price level rises and the economy moves up along AD. That rise is not a shift of AD.

Worked example 2: a classification

Say whether each is a movement or a shift, and which curve.

Event	Answer
Interest rates fall	Shift right of AD
Price level rises because AD has risen	Movement up along SRAS
Training lifts workers’ skills	Shift right of LRAS (and SRAS)
Energy costs rise	Shift left of SRAS
Foreign incomes fall	Shift left of AD

4.3.11 Equilibrium, real output, price level and employment

Macroeconomic equilibrium is where AD meets AS. At that point planned spending equals planned output, and there is no tendency for the price level or output to change. At a higher price level AS exceeds AD, stocks build up and firms cut prices and output. At a lower price level AD exceeds AS, stocks fall and prices rise.

Employment follows output in this model. More output needs more labour, so employment rises and unemployment falls. Less output means less employment. Equilibrium need not be at full employment, and it can lie below the vertical part of the curve.

Worked example 3: finding equilibrium from schedules

Country B (illustrative). Price level is an index (base = 100) and real output is in billion cu.

AD: real output demanded = 1,400 - 4P. SRAS: real output supplied = 600 + 4P.

Price level	AD	SRAS	Gap (AD - SRAS)
80	1,080	920	+160
90	1,040	960	+80
100	1,000	1,000	0
110	960	1,040	-80
120	920	1,080	-160

Equilibrium: 1,400 - 4P = 600 + 4P, so 8P = 800, P = 100 and real output = 1,000. At P = 110 there is a surplus of 80, so prices fall.

4.3.12 Effects of shifts

Worked example 4: shifts of AD and SRAS

Start from P = 100 and output = 1,000.

AD up by 80 at every price (AD: 1,480 - 4P). 1,480 - 4P = 600 + 4P gives P = 110 and output = 1,040. The price level rises 10%, output rises 4%, and employment rises because more labour is needed.

SRAS down by 80 (SRAS: 520 + 4P), for example after an energy cost rise. 1,400 - 4P = 520 + 4P gives P = 110 and output = 960. The price level rises 10%, output falls 4%, and employment falls. Higher prices with lower output is a supply shock.

SRAS up by 80 (SRAS: 680 + 4P), for example after a fall in raw material costs. 1,400 - 4P = 680 + 4P gives P = 90 and output = 1,040. The price level falls 10% and output rises 4%.

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

The split between output and prices depends on the slope of SRAS. On a flat section a shift in AD mostly changes output. On a steep section it mostly changes prices.

Worked example 5: the three-section LRAS

Country C (illustrative). The AS curve is flat at P = 50 up to output 800, rises to P = 140 at output 1,100 (P = 0.3 x output - 190 in this section), and is vertical at 1,100. AD is output = k - 4P, where k measures the AD position.

AD position	k	Section	Output	Price level
AD1	900	Flat	700	50
AD2	1,330	Upward	950	95
AD3	1,700	Vertical	1,100	150
AD4	1,900	Vertical	1,100	200

• AD1 to AD2: output +35.7%, price level +90%. Both rise.
• AD2 to AD3: output +15.8%, price level +57.9%. Prices rise faster than output.
• AD3 to AD4: output 0%, price level +33.3%. Capacity is the limit, so only prices respond.

A rightward shift of the vertical section (LRAS) is the only way to raise output at the full-capacity point. On the vertical-LRAS view, the economy returns to that output in the long run whatever happens to AD.

Evaluating AD/AS analysis

• Size and slope: the split between price and output depends on how elastic SRAS is, which depends on spare capacity.
• Shape of LRAS: the vertical view says AD only changes prices in the long run. The three-section view says it can raise output while spare capacity remains.
• Time lags: firms take time to raise capacity, so effects arrive over several periods.
• Other shifts: several curves can move at once (a cut in interest rates and a rise in oil prices), so the net effect is uncertain.

Common errors

• Writing “demand” on the diagram axes instead of “price level” and “real output”.
• Drawing a change in the price level as a shift of AD.
• Saying LRAS shifts when costs change. Cost changes shift SRAS.
• Forgetting that imports are subtracted in AD.
• Using micro reasons (substitutes) to explain the slope of AD.

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. This guide covers section 4.3.