A shock to aggregate demand or short-run aggregate supply moves the economy away from full employment. The direction of the shift tells you what happens to real GDP, the price level, and unemployment in the short run. Pick a shock below, or move the sliders, and read what an AP answer would say.
The economy starts in long-run equilibrium: real GDP of 1,000 billion (full employment), a price level of 100, and unemployment at the natural rate of 5%. Dashed grey lines show the starting curves once something moves.
A change in consumption, investment, government spending, or net exports shifts AD. When AD increases, real GDP and the price level both rise. When AD decreases, both fall. Unemployment moves opposite to real GDP.
A change in input prices, nominal wages, or productivity shifts SRAS. When SRAS decreases (shifts left), the price level rises and real GDP falls. When SRAS increases (shifts right), the price level falls and real GDP rises.
Inflation caused by an increase in aggregate demand. Buyers want more output than the economy produces at the old price level, so prices are pulled up. Real GDP rises at the same time.
Inflation caused by higher production costs, such as an oil price spike or higher nominal wages. Firms produce less at each price level, so the price level rises while real GDP falls.
A rising price level together with falling real GDP and rising unemployment. Only a leftward shift of SRAS produces both on its own. A demand shock always moves the price level and real GDP in the same direction.
When AD and SRAS shift at the same time, you know the direction of only one of real GDP or price level. The other depends on which shift is bigger. On the AP exam, call it indeterminate.
Each row starts from long-run equilibrium and shows only the short run. Memorize the pattern: AD moves price level and real GDP the same way; SRAS moves them in opposite ways.
| Event | Shift | Price level | Real GDP | Unemployment | Short-run gap |
|---|---|---|---|---|---|
| Consumer optimism, rise in household wealth | AD right | ↑ | ↑ | ↓ | Inflationary |
| Rise in net exports (foreign incomes rise) | AD right | ↑ | ↑ | ↓ | Inflationary |
| Fall in investment (business pessimism, higher real interest rates) | AD left | ↓ | ↓ | ↑ | Recessionary |
| Oil or other input price spike | SRAS left | ↑ | ↓ | ↑ | Recessionary (stagflation) |
| Rise in nominal wages | SRAS left | ↑ | ↓ | ↑ | Recessionary (stagflation) |
| Productivity gain, fall in input prices | SRAS right | ↓ | ↑ | ↓ | Inflationary if LRAS is held fixed. A lasting productivity gain also shifts LRAS right. |
| AD right and SRAS left | Both | ↑ | Indeterminate | Indeterminate | Depends on sizes |
| AD right and SRAS right | Both | Indeterminate | ↑ | ↓ | Inflationary |
| AD left and SRAS left | Both | Indeterminate | ↓ | ↑ | Recessionary |
| AD left and SRAS right | Both | ↓ | Indeterminate | Indeterminate | Depends on sizes |
AP-style multiple choice. Pick an answer to see the explanation.
The vocabulary for topic 3.6. Read the list, flip through flashcards, or quiz yourself. For every term in the unit, see the Unit 3 terminology guide.