# Short-Run Changes to the AD-AS Model

> AP Macroeconomics · AP Macroeconomics CED Unit 3
> Source: https://www.owlsprep.com/study/ap-macroeconomics-u3-short-run-changes-to-the/

This guide covers exogenous short-run shifts to aggregate demand and short-run aggregate supply, including demand/supply shocks, output gaps, stagflation, and multiplier calculations for output changes. Mastery is required for most AP Macroeconomics policy FRQs.

**Prerequisites:** Basic structure and definitions of the AD-AS model; Determinants of AD and SRAS curve shifts; Definition of the marginal propensity to consume (MPC)

## Learning objectives

- Identify positive and negative demand and supply shocks
- Predict short-run impacts of shocks on output, price level, and unemployment
- Calculate total output change using spending and tax multipliers
- Distinguish between stagflation from supply shocks and recession from demand shocks

## Overview of Short-Run AD-AS Changes

This topic analyzes how exogenous (external, non-price driven) changes to aggregate demand or short-run aggregate supply shift the relevant curve, creating a new short-run equilibrium with a different output level and price level. In the short run, nominal wages and other input prices are sticky, so the SRAS curve remains fixed after a shock, unlike long-run analysis which relies on input price adjustment.

This topic makes up ~10-12% of Unit 3 content, and ~2-3% of your overall AP exam score, appearing in both multiple-choice (MCQ) and free-response (FRQ) sections. It is the foundation for all business cycle and policy analysis in AP Macroeconomics.

> **info**
>
> Standard AP exam notation: Rightward shifts = outward (increase in quantity), leftward shifts = inward (decrease in quantity). Use subscript 1 for original curves, subscript 2 for shifted curves.

## Demand Shocks and AD Shifts

**Demand Shock** — An exogenous change to any component of aggregate demand that shifts the entire AD curve, rather than causing movement along the existing curve. Can be expansionary (positive) or contractionary (negative).

*Notation:* $AD = C + I + G + (X-M)$

*Example:* An increase in consumer confidence is a positive demand shock.

Positive demand shocks shift AD rightward, and include increases in consumer confidence, higher government spending, tax cuts, lower interest rates, or increased export demand. Negative demand shocks shift AD leftward, caused by decreases in any AD component. When AD shifts, the new short-run equilibrium is the intersection of the shifted AD and the unchanged original SRAS.

A rightward AD shift increases both equilibrium real output ($Y$) and the aggregate price level ($PL$). If new output is above potential output ($Y_p$), the economy has an inflationary gap. A leftward AD shift decreases both output and price level, creating a recessionary gap if output is below $Y_p$. By Okun's law, higher output reduces cyclical unemployment, and lower output increases it.

**Worked example:** A country is initially at long-run equilibrium with potential output of \$20 trillion. The central bank cuts interest rates, reducing borrowing costs for households and firms, ceteris paribus. Identify the type of shock, shift direction, and short-run impact on output, price level, and cyclical unemployment.

1. Lower interest rates increase consumption (for households) and investment (for firms), which are both components of AD. This is a positive (expansionary) demand shock.
2. The entire AD curve shifts rightward, while SRAS and LRAS remain unchanged in the short run (input prices are sticky, and potential output has not changed).
3. The new short-run equilibrium intersection occurs at real output $Y_2 > Y_p = 20$ trillion, and a higher aggregate price level $PL_2 > PL_1$.
4. Since output is above potential, cyclical unemployment falls below the natural rate of unemployment.

> **Exam tip:** On AP FRQs, always explicitly label original curves ($AD_1$, $SRAS_1$), shifted curves ($AD_2$), original and new equilibrium points, and mark potential output $Y_p$ to earn all possible graphing points.

## Supply Shocks and SRAS Shifts

**Supply Shock** — An exogenous change to per-unit production costs or productivity that shifts the entire short-run aggregate supply (SRAS) curve. Unlike demand shocks, supply shocks create a trade-off between inflation and unemployment that cannot occur with demand shifts.

*Example:* A spike in global oil prices is a negative supply shock.

Common causes of SRAS shifts include changes in energy/commodity prices, nominal wage changes, import prices for intermediate goods, productivity changes, and regulatory changes. A negative (adverse) supply shock increases production costs, shifting SRAS leftward: the new equilibrium has lower output and higher prices, a harmful combination called stagflation. A positive (beneficial) supply shock reduces production costs, shifting SRAS rightward, leading to higher output, lower prices, and lower unemployment.

**Worked example:** A widespread drought reduces agricultural output across a large economy, raising the price of domestic food and raw materials. The economy is initially at long-run equilibrium at potential output. Describe the short-run impact of this shock on the economy.

1. Higher food and raw material prices increase per-unit production costs for all firms relying on these inputs. This is a negative (adverse) aggregate supply shock.
2. The entire SRAS curve shifts leftward, while AD and LRAS remain unchanged in the short run.
3. The new intersection of $SRAS_2$ and original $AD_1$ occurs at real output $Y_2 < Y_p$ and aggregate price level $PL_2 > PL_1$.
4. Lower output means fewer workers are needed, so cyclical unemployment rises above the natural rate, while higher prices cause higher inflation. This outcome is stagflation.

> **Exam tip:** AP MCQs almost always test the stagflation distinction. Remember: only a leftward shift of SRAS causes stagflation. A leftward shift of AD causes lower output and lower inflation, never stagflation.

## Multiplier Effect of AD Shifts

The multiplier effect describes how an initial change in aggregate demand leads to a larger total change in short-run equilibrium output. This occurs because initial spending becomes income for other households, who spend a portion of that income, creating additional rounds of spending that add to the total change. The multiplier size depends on the marginal propensity to consume (MPC), the share of additional income that households spend rather than save.

The spending multiplier, used for initial changes in government spending, investment, or exports, where $MPS$ is the marginal propensity to save, is:

$$k = \frac{1}{1 - MPC} = \frac{1}{MPS}$$

For changes in lump-sum taxes, the tax multiplier is smaller, because only the MPC portion of a tax change is spent in the first round:

$$k_t = -\frac{MPC}{1 - MPC}$$

The total change in short-run equilibrium output is $\Delta Y = k \times \Delta G$ for spending changes, and $\Delta Y = k_t \times \Delta T$ for tax changes, where $\Delta T$ is negative for a tax cut.

**Worked example:** Suppose an economy has an MPC of 0.6, and is in a deep recession with a flat SRAS curve (so the price level does not change as output increases). The government increases spending on public education by \$300 billion. Calculate the total change in short-run equilibrium real output.

1. First, confirm the type of change: this is an initial change in government spending, so we use the spending multiplier formula.
2. Calculate the spending multiplier:
3. $$k = \frac{1}{1 - 0.6} = \frac{1}{0.4} = 2.5$$
4. The initial change in spending $\Delta G = +300$ billion.
5. Calculate total change in output:
6. $$\Delta Y = k \times \Delta G = 2.5 \times 300 = +750$$
7. Short-run equilibrium real output increases by a total of \$750 billion.

**Check your understanding**

Test your understanding with these AP-style questions:

1. Which of the following is the most likely short-run impact of a sharp decline in business investment, when the economy is initially at long-run equilibrium?

   - A) Real output decreases, price level decreases, cyclical unemployment increases
   - B) Real output increases, price level increases, cyclical unemployment decreases
   - C) Real output increases, price level decreases, cyclical unemployment decreases
   - D) Real output decreases, price level increases, cyclical unemployment increases

   *Answer:* A) Real output decreases, price level decreases, cyclical unemployment increases

   *Why:* Business investment is a component of aggregate demand, so a decline shifts AD left. This results in lower output, lower price level, and higher cyclical unemployment. Only a leftward SRAS shift causes higher prices and lower output.

2. The U.S. government issued \$900 billion in stimulus checks equivalent to a lump-sum tax cut. If MPC = 0.75, what is the total expected increase in short-run output?

   - A) \$900 billion
   - B) \$1.8 trillion
   - C) \$2.7 trillion
   - D) \$3.6 trillion

   *Answer:* C) \$2.7 trillion

   *Why:* Use the tax multiplier formula: $k_t = -0.75/(1-0.75) = -3$. With $\Delta T = -900$ billion, $\Delta Y = (-3) \times (-900) = +2700$ billion = \$2.7 trillion.

> **Exam tip:** Never mix up the spending and tax multipliers. The tax multiplier has a smaller absolute value than the spending multiplier, because a portion of any tax cut is saved rather than spent. AP MCQs almost always list the spending multiplier result as a trap answer for tax change questions.

## Common pitfalls

- **Wrong:** Calling a leftward shift of aggregate demand a cause of stagflation
  - Why it fails: Students confuse the price level impact of left shifts for AD vs SRAS, and assume any decrease in output will be paired with higher inflation
  - Correct: Memorize the rule: stagflation (high unemployment + high inflation) only comes from a leftward shift of SRAS; left AD shifts cause high unemployment and lower inflation
- **Wrong:** Shifting SRAS in the short run when there is a change in government spending
  - Why it fails: Students mix up the determinants of AD vs SRAS shifts, and incorrectly shift both curves when only one is affected
  - Correct: In the short run, only the curve directly impacted by the shock shifts; government spending changes impact AD, not SRAS, so leave SRAS unchanged unless input prices have explicitly changed
- **Wrong:** Using the spending multiplier instead of the tax multiplier to calculate the output change from a \$100 billion tax cut
  - Why it fails: Students remember the multiplier formula but forget that tax changes have a smaller first-round impact because part of the tax cut is saved
  - Correct: Always identify the type of initial AD change first: use $k = 1/(1-MPC)$ for changes in G or I, use $k_t = -MPC/(1-MPC)$ for changes in lump-sum taxes
- **Wrong:** Claiming cyclical unemployment increases after a rightward shift of AD
  - Why it fails: Students mix up the inverse relationship between output and unemployment, or confuse nominal vs real output changes
  - Correct: Always remember: higher real output = more workers needed = lower cyclical unemployment; lower real output = fewer workers needed = higher cyclical unemployment
- **Wrong:** Shifting LRAS along with AD in short-run analysis
  - Why it fails: Students forget that LRAS only shifts when potential output changes (e.g., from a change in technology or labor force), not from demand shocks
  - Correct: Leave LRAS in its original position for short-run analysis unless the question explicitly states that potential output has changed

## Cheatsheet

| Category | Formula / Rule | Notes |
| --- | --- | --- |
| Spending Multiplier | $k = \frac{1}{1-MPC}$ | Applies to initial changes in G, I, or exports |
| Tax Multiplier | $k_t = -\frac{MPC}{1-MPC}$ | Negative sign because higher taxes reduce output; absolute value < spending multiplier |
| Total Output Change (Spending) | $\Delta Y = k \times \Delta G$ | Maximum change when SRAS is flat; actual change smaller if price level rises |
| Positive Demand Shock | AD shifts right | Outcome: $\uparrow Y$, $\uparrow PL$, $\downarrow$ unemployment; inflationary gap if $Y > Y_p$ |
| Negative Demand Shock | AD shifts left | Outcome: $\downarrow Y$, $\downarrow PL$, $\uparrow$ unemployment; recessionary gap if $Y < Y_p$ |
| Negative Supply Shock | SRAS shifts left | Outcome: $\downarrow Y$, $\uparrow PL$, $\uparrow$ unemployment; causes stagflation |
| Positive Supply Shock | SRAS shifts right | Outcome: $\uparrow Y$, $\downarrow PL$, $\downarrow$ unemployment |

## What's next

Short-run changes to the AD-AS model are the immediate foundation for long-run AD-AS adjustment, the next core topic in Unit 3. After a short-run shock creates a recessionary or inflationary gap, sticky input prices adjust over time, shifting SRAS back to long-run equilibrium at potential output. Without correctly identifying the short-run change after a shock, you cannot analyze the long-run adjustment process that AP exams frequently test. This topic is also a prerequisite for analyzing the impact of fiscal and monetary policy, the core topics of Unit 4. All policy analysis relies on predicting how policy shifts AD (or SRAS) and changes short-run output and inflation, so mastering this sub-topic is critical for higher-scoring FRQ responses.

- [Long-Run Adjustment to Macroeconomic Shocks](https://www.owlsprep.com/study/ap-macroeconomics-u3-long-run-adjustment-to-macroeconomic/)
- [Fiscal Policy](https://www.owlsprep.com/study/ap-macroeconomics-u3-fiscal-policy/)
- [Automatic Stabilizers](https://www.owlsprep.com/study/ap-macroeconomics-u3-automatic-stabilizers/)

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