Fiveable
Fiveable
crams
try guided practice free
try guided practice free
AP Macroeconomics
Find gaps with guided practice
Guided practice grid visualization
Table of Contents
Unit 3 Overview: National Income and Price Determination
3.1 Aggregate Demand
3.2 Spending and Tax Multipliers
3.3 Short-Run Aggregate Supply (SRAS)
3.4 Long-Run Aggregate Supply (LRAS)
3.5 Equilibrium in Aggregate Demand-Aggregate Supply (AD-AS) Model
3.6 Changes in the AD-AS Model in the Short Run
3.7 Long-Run Self-Adjustment
3.8 Fiscal Policy
3.9 Automatic Stabilizers

💶ap macroeconomics review

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

Verified for the 2025 AP Macroeconomics exam•Citation:

GDP Determinants

In our initial discussion, we identified that there were determinants that would shift both aggregate demand and aggregate supply. The determinants of aggregate demand are the various types of spending that make up the formula for GDP: 

  • consumer spending 🛒
  • investment spending 💵
  • government spending 💰
  • net exports (exports-imports) 💸

The determinants of aggregate supply include resource prices and availability, actions of the government, and productivity/technology. All of these determinants for both aggregate demand and aggregate supply can cause a shift of the corresponding curve either left (decrease) or right (increase).  

Negative Supply Shock

In addition to these determinants of aggregate demand and aggregate supply, changes in the AD-AS Model can also occur from both negative supply shocks and positive supply shocks. A negative supply shock is an unexpected decrease in the availability of a key resource that temporarily decreases productivity. A negative supply shock will raise production costs and reduce the quantity that producers are willing to supply at any price level. This leads to a leftward shift of the short-run aggregate supply curve. 

A real-life example of a negative supply shock is the disruptions to the world oil supplies that happen in 1973 and 1979. It was seen as a negative supply shock because it all happened at once when OPEC (Organization of Petroleum Exporting Countries) placed an embargo on oil exports to the United States. This caused a decrease in the supply of oil and caused prices to rise. This also caused a fear that we would not be able to fill up at the gas tank, heat our homes, or run our factories. 

Positive Supply Shock

A positive supply shock is an unexpected increase in the availability of a key resource that temporarily increases productivity. A positive supply shock will lower production costs and increase the quantity that producers are willing to supply at any price level. A good real-life example of a positive supply shock is the time period between 1995 and 2000 when there was an increasing use of the internet and other information technologies. This caused a huge growth in productivity.

AD⬆ leads to real GDP⬆, unemployment⬇ and price level⬆

AD⬇ leads to real GDP⬇, unemployment⬆ and price level⬇

SRAS⬆ leads to real GDP⬆, unemployment⬇ and price level⬇

SRAS⬇ leads to real GDP⬇ , unemployment⬆ and price level⬆

Let's look at some various scenarios that would cause short run changes in the AD-AS model.  

Scenario # 1: Consumer Income Decreases as Taxes Increase

When taxes are increased, that allows for less consumer disposable income. This, in turn, will lead to consumers spending less money. The component of aggregate demand known as consumer spending will decrease, which leads to a decrease (leftward shift) of the aggregate demand curve. This causes a decrease in price level and a decrease in GDP. 

Scenario # 2: The British government increases tariffs on imported inputs

Tariffs are taxes on goods. In this particular scenario, the British government is placing tariffs on inputs (resources) that are coming into the country. That will raise the cost of these inputs (resources), making production costs greater for individual companies. With greater production costs, firms will produce less of their goods. This is shown by a decrease in the SRAS (shift to the left). This causes an increase in price level and a decrease in GDP.

Scenario # 3: Spanish exports become cheaper on the world market.

When the costs of exports become cheaper, other countries will be more willing to purchase goods from Spain. As they purchase more goods, this will affect the determinant known as net exports. When exports increase, net exports also increase. This causes an increase in aggregate demand (shift to the right) which causes an increase in price level and an increase in GDP.

Scenario #4: Corporate Taxes are reduced

When corporate taxes are decreased, it lowers production costs for firms (businesses). With the lowering of production costs, the firms are able to increase their overall output. This is shown by shifting the SRAS to the right. This increase in the SRAS will cause the overall price level to drop and the real GDP to increase.

Key Terms to Review (15)

Aggregate Supply: Aggregate Supply is the total quantity of goods and services that producers in an economy are willing and able to supply at different price levels over a specific time period. It is crucial in understanding how the economy responds to changes in demand and how these shifts affect overall production, employment, and prices. Changes in aggregate supply can occur due to factors like input prices, technology advancements, and government policies, impacting economic growth and stability.
Aggregate demand: Aggregate demand is the total quantity of goods and services demanded across all levels of the economy at a given overall price level and in a given time period. It reflects the total spending on domestic goods and services in an economy, encompassing consumption, investment, government spending, and net exports. Changes in aggregate demand can influence economic growth, inflation, and employment levels.
Consumer Spending: Consumer spending refers to the total amount of money that households use to purchase goods and services over a specific period. This spending is crucial as it drives demand in the economy, impacting overall economic growth and influencing fiscal and monetary policies, particularly in short-run economic fluctuations.
Corporate Taxes: Corporate taxes are taxes imposed on the income or profit of corporations, which are separate legal entities. These taxes play a crucial role in government revenue and can impact business investment decisions, employment rates, and overall economic growth. By influencing how corporations allocate resources, corporate taxes are an essential factor in the dynamics of the aggregate demand and aggregate supply (AD-AS) model, especially in the short run.
GDP: Gross Domestic Product (GDP) is the total monetary value of all finished goods and services produced within a country's borders in a specific time period. It serves as a comprehensive measure of a nation’s overall economic activity, reflecting the health of the economy, and connects various concepts such as economic growth, inflation adjustments, and the impact of demand and supply changes in short-term economic scenarios.
Government Spending: Government spending refers to the total amount of money that a government allocates for public services, infrastructure, and welfare programs. It plays a crucial role in influencing economic activity, as it directly affects aggregate demand and can stimulate growth during economic downturns while also having implications for fiscal policy and overall economic stability.
Investment Spending: Investment spending refers to the expenditure on capital goods that will be used for future production, such as machinery, buildings, and equipment. This type of spending is crucial for economic growth as it influences the overall level of aggregate demand and can be impacted by changes in interest rates, government policies, and consumer confidence.
Negative Supply Shock: A negative supply shock refers to an unexpected event that reduces the supply of goods and services in an economy, leading to higher prices and lower output. This disruption can occur due to various factors such as natural disasters, geopolitical tensions, or sudden increases in the price of key resources like oil. The effects of a negative supply shock can be significant, causing shifts in the aggregate supply curve and altering the dynamics of the economy in the short run.
Net Exports: Net exports refer to the value of a country's total exports minus its total imports. This figure is crucial in understanding a nation's trade balance and plays a significant role in determining its economic health and influences aggregate demand.
Price level: The price level refers to the average level of prices in the economy at a specific point in time, typically measured by indices like the Consumer Price Index (CPI) or the GDP deflator. It plays a crucial role in understanding inflation, purchasing power, and the overall economic health, influencing monetary and fiscal policy decisions.
Productivity/Technology: Productivity refers to the efficiency with which goods and services are produced, often measured as the output per labor hour. Technology plays a crucial role in enhancing productivity by introducing new methods, processes, and tools that enable workers to produce more efficiently and effectively. Together, productivity and technology influence economic growth, shifting aggregate supply and demand dynamics in the economy.
Real GDP: Real GDP, or Real Gross Domestic Product, measures the value of all final goods and services produced within a country in a given time period, adjusted for inflation. This adjustment allows for a more accurate comparison of economic output over time, reflecting the true growth and productivity of an economy without the distortions caused by changes in price levels.
Resource Prices: Resource prices refer to the costs associated with acquiring the inputs needed for production, including labor, raw materials, and capital. Changes in these prices can significantly impact the overall supply in an economy, influencing production costs and ultimately affecting the short-run and long-run aggregate supply curves.
Tariffs: Tariffs are taxes imposed by a government on imported goods, designed to increase the cost of foreign products and protect domestic industries. By making imported goods more expensive, tariffs aim to encourage consumers to buy domestically produced items, which can influence trade balances and impact currency values in the foreign exchange market.
Unemployment rate: The unemployment rate is the percentage of the labor force that is jobless and actively seeking employment. It reflects the health of the economy, with rising rates often indicating economic distress and falling rates signaling improvement. Understanding this metric is crucial as it connects to changes in economic activity, labor market dynamics, and monetary policy responses.
Back
Practice QuizGlossary
3.7 Long-Run Self-Adjustment