This document discusses macroeconomic equilibrium using aggregate demand (AD) and aggregate supply (AS) analysis. It provides diagrams showing: 1) How macroeconomic equilibrium is established at the point where AD intersects short-run aggregate supply (SRAS). 2) How an increase in AD leads to expansion of output and a higher equilibrium price level, while an increase in AS expands both AD and output. 3) It also shows how a decrease in either AD or AS results in a contraction of output and a lower equilibrium price level.

1. AS Macro Revision
Macroeconomic Equilibrium
Spring 2014

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3. Macroeconomic Equilibrium using AD-AS
General
Price Level
Macro-economic
equilibrium is
established when AD
intersects with SRAS
AS
What matters is whether
total demand for goods
and services (AD) is close
to actual production from
domestic and external
sources
GPL1
AD
Y1
Real GDP

4. Impact of an increase in Aggregate Demand
General
Price Level
An increase in AD causes an expansion of aggregate supply and a
higher equilibrium level of national output (i.e. higher real GDP)
AS
GPL2
GPL1
AD2
AD1
Y1
Y2
Real GDP

5. Impact of an increase in Aggregate Supply
General
Price Level
An increase in AS causes an expansion of AD and a higher
equilibrium level of national output (i.e. higher real GDP)
AS1
AS2
GPL1
GPL2
AD
Y1
Y2
Real GDP

6. Impact of a fall in Aggregate Demand
General
Price Level
A decrease in AD causes a contraction of AS and a lower
equilibrium level of national output (i.e. lower real GDP)
AS
GPL1
GPL2
AD1
AD2
Y2
Y1
Real GDP

7. Impact of a fall in Aggregate Supply
General
Price Level
A decrease in AS causes a contraction of AS and a lower
equilibrium level of national output (i.e. lower real GDP)
AS2
AS1
GPL2
GPL1
AD
Y2
Y1
The effect of a
decrease in AS will
partly depend on
the cause. A
decrease in
investment will be
particularly harmful
as it will also
decrease aggregate
demand
Real GDP

8. Economic Effects of a Fall in Aggregate Supply (AS)
Aggregate supply can fall both in the short run and in the long run
– possible causes are outlined on the left and some of the
macroeconomic consequences are covered on the right
Some Causes of Fall in
Aggregate Supply
Brain drain – an outward
migration of workers
Collapse in business
capital investment
Possible Macro
Consequences
May cause higher inflation
May reduce real
GDP/national output
Higher production costs
May reduce employment
Effects of a major natural
disaster / shock
May increase a BoP
current account deficit

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