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Macroeconomics Foundations (ECON 102) · Module 2 of 7

Aggregate Demand & Aggregate Supply

What shifts AD, SRAS and LRAS, how the economy reaches equilibrium, and recessionary vs. inflationary gaps.

In this module
  1. Aggregate Demand
  2. Short-Run & Long-Run Aggregate Supply
  3. Output Gaps & Self-Correction
  4. Check yourself

Aggregate Demand

  • AD slopes downward because of the wealth effect, the interest-rate effect, and the exchange-rate (net export) effect.
  • AD shifts with changes in its components: consumer confidence or wealth (C), business expectations or interest rates (I), government spending (G), and foreign incomes or exchange rates (NX).
Worked example

Consumer confidence falls sharply. What happens to AD, real output, and the price level in the short run?

Solution. Consumption drops, so AD shifts left. Real GDP and the price level both fall in the short run.

Short-Run & Long-Run Aggregate Supply

  • SRAS slopes upward because some input prices (especially wages) are sticky in the short run. It shifts with input prices, productivity, and supply shocks (e.g. an oil price spike shifts SRAS left).
  • LRAS is vertical at full-employment (potential) output. It shifts right with more resources, better technology, or more human capital.
  • A negative supply shock causes stagflation: higher prices together with lower output.
Worked example

Oil prices triple. Use AD–AS to predict the short-run effects.

Solution. Production costs rise, so SRAS shifts left. The price level rises and real GDP falls (stagflation), and unemployment rises.

Output Gaps & Self-Correction

  • Recessionary gap: equilibrium output is below potential, and unemployment exceeds the natural rate. Inflationary gap: output is above potential.
  • Without policy, the economy self-corrects in the long run as wages adjust. In a recessionary gap, wages eventually fall, SRAS shifts right, and output returns to potential at a lower price level.
Worked example

An economy is in an inflationary gap. Describe the long-run self-correction.

Solution. Workers demand higher wages, so SRAS shifts left until output returns to potential, at a higher price level.

Common mistake: Draw and label AD, SRAS and LRAS every time. Most AP Macro free-response points come from a correctly labeled graph and a correct shift.

Check yourself

2 of this module's 5 quiz questions. Pick your answers, then check them in the app, with an explanation for every question.

1. Which would shift aggregate demand to the right?

2. A sudden rise in the price of oil will, in the short run:

Check my answers, free