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Unit 3:
Aggregate Demand and
Supply and Fiscal Policy
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Shifters of Aggregate Demand
AD = C + I + G + X
Change in Consumer Spending
Change in Investment Spending
Change in Government Spending
Net EXport Spending
Shifters of Aggregate Supply
AS = R + A + P
Change in
Change in
Change in
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Resource Prices
Actions of the Government
Productivity
2
Putting AD and AS together to get
Equilibrium Price Level and Output
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Use the AD and AS model to show an
economy at full employment output
Price
Level
LRAS
AS
PLe
AD
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QY
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#1. Assume there is an increase in consumer
spending. What happens to PL and output in the
short- run?
LRAS
Price
Level
AS
PL and Q will
Increase
PL1
PLe
AD
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QY Q1
AD1
GDPR
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Practice
AD or AS
Shifter
Increase or
Decrease
1
2
3
4
5
6
7
8
9
10
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Practice
1. An increase in consumer spending
2. The impact on net exports when a trading
partner has a recession
3. A significant increase in the price of oil that
affects the resource costs of businesses
4. Government increases spending but not taxes
5. Increase in wages that businesses pay workers
6. Effect on businesses when they expect inflation
7. Effect on investment when interest rates
decrease
8. An increase in productivity
9. The impact on next exports when the country’s
currency depreciates
10. Government increases corporate taxes
7
Practice
AD or AS
Shifter
Increase or Decrease
1
2
AD
AD
C
X
Increase
Decrease
3
4
5
6
7
AS
AD
AS
AS
AD
R
G
R
R
I
Decrease
Increase
Decrease
Decrease
Increase
8
AS
P
Increase
9
10
AD
AS
X
A
Increase
Decrease
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Inflationary and
Recessionary Gaps
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The economy can only be in one of
three places at any time
Capital Goods
Max Capacity
0% Unemployment
Real
GDP
Real
GDP
Consumer Goods
Full Employment
5% Unemployment
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Time
Recessionary Gap
Full Employment
Inflationary Gap
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Example: Assume the government increases
spending. What happens to PL and Output?
Price
Level
LRAS
AS
PL and Q will
Increase
PL1
PLe
AD
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QY Q1
AD1
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Inflationary Gap
Output is high and unemployment is less than NRU
LRAS
Price
Level
AS
Actual GDP
above potential
GDP
PL1
AD1
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QY Q1
GDPR
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Example: Assume consumer spending falls.
What happens to PL and Output?
LRAS
Price
Level
AS
PL and Q will
decrease
PLe
PL1
AD1
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Q1
QY
AD
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Recessionary Gap
Output low and unemployment is more than NRU
LRAS
Price
Level
AS
Actual GDP
below potential
GDP
PL1
AD1
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Q1
QY
GDPR
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Example: If there is a negative “supply shock”
of oil. What happens to PL and Output?
Price
Level
LRAS
AS1
AS
Stagflation
PL1
Stagnate Economy
+ Inflation
PLe
Still considered
recessionary gap
AD
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2008 Audit Exam
2008 Audit Exam
2008 Audit Exam
2012 Exam
AD and AS Practice
Worksheet
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What Happens In
the Long-Run?
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If consumer spending increases, what will
happen in the short-run and in the long-run?
In the long-run, wages and costs increase
LRAS
AS1
Real
GDP
Price
Level
AS
PL2
Real
GDP
PL1
PLe
AD AD1
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QY Q1
GDPR
Time
23
If consumer spending increases, what will
happen in the short-run and in the long-run?
In the long-run, wages and costs increase
LRAS
AS1
Real
GDP
Price
Level
PLe
Real
GDP
AD1
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QY
GDPR
Time
24
If consumer spending decreases, what will
happen in the short-run and in the long-run?
In the long-run, wages & costs eventually decrease
LRAS
Price
Level
AS
Real
GDP
AS2
PLe
PL1
Real
GDP
PL2
AD2 AD
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Q1 QY
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Time
25
Practice
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#1. Assume there is an increase in government
spending. What happens to PL and output in the
short- run?
LRAS
Price
Level
AS
PL and Q will
Increase
PL1
PLe
AD
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QY Q1
AD1
GDPR
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#2. Consumer expectations fall and consumer
spending plummets. What happens to price level
and output in the long-run?
Price
Level
LRAS
AS
AS1
Price Level
decreases and
output stay s the
AD same
PLe
PL1
PL2
AD1
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Q1 QY
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#3. If consumer spending increases, what happens
to price level and output in the long-run?
Price
Level
LRAS
AS1
AS
PL2
Price level
increases and
output stays the
same
PL1
PLe
AD
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QY Q1
AD1
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2008 Audit Exam
Economic Growth
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If investment increases, what happens in the
short-run and long-run?
Capital Stock- Machinery and tools purchased by
businesses that increase their output
LRAS LRAS1
AS AS1
PL1
PLe
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QY
AD1
AD
Q1 QY1 GDPR
Capital Goods
Price
Level
The PPC shifts outward since
producers can make more
Consumer Goods
32
An increase in consumption or government
spending doesn’t cause economic growth.
Only Investment causes growth since firms
increase their capital stock
LRAS1
AS1
Capital Goods
Price
Level
PLe
AD1
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Consumer Goods
33
2008 Audit Exam
2008 Audit Exam
2012 FRQ #3
36
2012 FRQ #3
37