Aggregate Supply – Aggregate Demand

The flagship macro diagram: demand shocks, supply shocks, and the short-run vs. long-run distinction.

Equilibrium: Y* = 53.1, P* = 42.2

Current equations

AD: P = 90 − 0.9·YSRAS: P = 5 + 0.7·YLRAS: Y = 50

The whole economy in one diagram. AD shows total spending at each price level; SRAS shows what firms produce in the short run; the vertical LRAS marks potential output, what the economy can sustain. Demand shocks move output and prices the same direction; supply shocks move them opposite ways.

Source: Mankiw, Macroeconomics, ch. 10-14; Blanchard ch. 7

Shift the curves

Aggregate demand (C, I, G, NX)0

Spending changes, consumption, investment, government, net exports, shift AD.

Short-run supply (input costs, expectations)0

Higher input costs shift SRAS up/left; lower costs shift it down/right.

Worked examples

The Aggregate Supply – Aggregate Demand model, in writing

Definition

The whole-economy version of supply and demand: aggregate demand (total spending at each price level) meets short-run aggregate supply to determine real output and the price level together.

AD: Y = C + I + G + NX (falls as P rises) ; SRAS slopes up ; LRAS vertical at potential output Y*

The intuition

Demand shocks (stimulus, confidence, rate cuts) move output and prices the SAME direction; supply shocks (oil, wages, drought) move them in OPPOSITE directions, which is why stagflation is the tell-tale sign of a supply problem. In the long run wages adjust, SRAS shifts back, and only prices remain changed.

Exam tip

State which curve shifts, which way, and what happens to BOTH output and the price level. A demand-shock answer that forgets the price level, or a supply-shock answer that has prices and output moving together, loses the marks.

Related models in Macro Foundations

Keynesian Cross & the Multiplier →Phillips Curve →Business Cycle Phases →Money Multiplier →