3.6 Changes in the AD-AS Model in the Short Run

Shocks Shift AD or SRAS

Changes in consumption, investment, government spending, or net exports shift AD. Changes in input prices, productivity, or supply shocks shift SRAS. A rightward AD or SRAS shift is expansionary; leftward is contractionary. Each shift moves the economy to a new short-run equilibrium where new price level (PL) and real GDP (RGDP) are determined.

Demand-Side Shocks

An increase in AD (e.g., rising consumer confidence, tax cuts, higher exports) raises both PL and RGDP in the short run. A decrease in AD lowers both PL and RGDP, causing a recessionary gap if RGDP falls below full-employment output (potential GDP).

Supply-Side Shocks

A decrease in SRAS (e.g., rising oil prices) causes stagflation: PL rises while RGDP falls — this is a negative supply shock. An increase in SRAS (e.g., falling input costs, tech improvement) lowers PL and raises RGDP simultaneously, unlike demand shocks which move PL and RGDP in the same direction.

Key terms

Negative supply shock

An event (e.g., rising input costs) that shifts SRAS left, causing stagflation: higher price level, lower real GDP.

Stagflation

Simultaneous rise in price level and fall in real GDP, typically caused by a decrease in SRAS.

Recessionary gap

When short-run equilibrium real GDP is below full-employment (potential) GDP.

Effect of AD shifts

Price level and real GDP move in the SAME direction (both increase with AD increase, both decrease with AD decrease).

Effect of SRAS shifts

Price level and real GDP move in OPPOSITE directions (SRAS increase lowers PL, raises RGDP; SRAS decrease raises PL, lowers RGDP).

Try an AP-style question

A decrease in AD in the short run causes…

1. higher price level and real GDP
2. higher prices, lower GDP
3. lower prices, higher GDP
4. lower price level and real GDP