Short-Run Changes to the AD-AS Model — AP Macroeconomics Study Guide

For: AP Macroeconomics candidates sitting AP Macroeconomics.

Covers: Shifts in aggregate demand (AD) and short-run aggregate supply (SRAS), demand shocks, supply shocks, recessionary/inflationary output gaps, stagflation, and multiplier effects on short-run equilibrium output and price level.

You should already know: 1) Basic structure and definitions of the AD-AS model, 2) Determinants of AD and SRAS curve shifts, 3) Definition of the marginal propensity to consume (MPC).

A note on the practice questions: All worked questions in the "Practice Questions" section below are original problems written by us in the AP Macroeconomics style for educational use. They are not reproductions of past College Board / Cambridge / IB papers and may differ in wording, numerical values, or context. Use them to practise the technique; cross-check with official mark schemes for grading conventions.

1. What Is Short-Run Changes to the AD-AS Model?

This topic analyzes how exogenous (external, not price-driven) changes to aggregate demand or short-run aggregate supply shift the relevant curve, resulting in a new short-run equilibrium with a different output level and price level. Unlike long-run changes, which rely on flexible input price adjustment, short-run changes assume nominal wages and other input prices are sticky, so the SRAS curve remains upward-sloping and fixed after a demand shock, for example.

According to the AP Macroeconomics Course and Exam Description (CED), this topic makes up ~10-12% of Unit 3 content, and roughly 2-3% of the overall AP exam score. It appears in both multiple-choice (MCQ) and free-response (FRQ) sections, and is almost always the core of any AD-AS policy question on the exam. The standard notation used on the AP exam is: rightward shifts are outward (increasing quantity), leftward shifts are inward (decreasing quantity), with subscripts 1 for original curves and 2 for shifted curves. This topic is the foundation for analyzing business cycles and policy effectiveness, the core of AP Macroeconomics.

2. Demand Shocks and AD Shifts

A demand shock is an exogenous change to any component of aggregate demand ($AD=C+I+G+(X-M)$) that shifts the entire AD curve, rather than causing a movement along the existing curve. Demand shocks can be expansionary (positive) or contractionary (negative). Positive demand shocks that shift AD right include increases in consumer confidence, higher government spending, tax cuts, lower interest rates, or increased foreign demand for exports. Negative demand shocks that shift AD left include decreases in any of these components.

When AD shifts, the new short-run equilibrium is the intersection of the shifted AD and the original, unchanged SRAS. A rightward AD shift increases both equilibrium real output ($Y$) and the aggregate price level ($PL$). If the new output is above potential output ($Y_p$, where LRAS is located), the economy has an inflationary gap. A leftward AD shift decreases both equilibrium output and price level, resulting in a recessionary gap if output is below $Y_p$. By Okun’s law, higher output reduces cyclical unemployment, and lower output increases cyclical unemployment.

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 $P{L}_2>P{L}_1$.
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 ($A{D}_1$, $SRA{S}_1$), shifted curves ($A{D}_2$), original and new equilibrium points ($Y_1,P{L}_1$ and $Y_2,P{L}_2$), and mark potential output $Y_p$ to earn all possible graphing points.

3. Supply Shocks and SRAS Shifts

A supply shock is 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 happen with a demand shift. Common causes of SRAS shifts include changes in energy/commodity prices, changes in nominal wages, changes in import prices for intermediate goods, changes in productivity, or changes in business regulation.

A negative (adverse) supply shock increases production costs, shifting SRAS leftward. The new short-run equilibrium has lower output and a higher price level: this combination of high unemployment and high inflation is called stagflation, a uniquely harmful macroeconomic outcome that is hard to correct with standard stabilization policy. A positive (beneficial) supply shock reduces production costs, shifting SRAS rightward, resulting in higher output, lower price level, 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 food producers, manufacturers, and service firms that rely 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 $SRA{S}_2$ and original $A{D}_1$ occurs at real output $Y_2<Y_p$ and aggregate price level $P{L}_2>P{L}_1$.
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.

4. 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 happens because the initial round of 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 size of the multiplier depends on the marginal propensity to consume (MPC), the share of additional income that households spend rather than save.

The spending multiplier (for initial changes in government spending, investment, or exports) is: $$k=\frac{1}{1-MPC}=\frac{1}{MPS}$$ where $MPS$ is the marginal propensity to save. 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: $k=\frac{1}{1-0.6}=\frac{1}{0.4}=2.5$.
3. The initial change in spending $\Delta G=+300$ billion.
4. Total change in output: $\Delta Y=k\times \Delta G=2.5\times 300=+750$ billion.
5. Short-run equilibrium real output increases by a total of $750 billion.

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.

5. Common Pitfalls (and how to avoid them)

• Wrong move: Calling a leftward shift of aggregate demand a cause of stagflation. Why: 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 move: 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 move: Shifting SRAS in the short run when there is a change in government spending. Why: Students mix up the determinants of AD vs SRAS shifts, and incorrectly shift both curves when only one is affected. Correct move: 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 move: Using the spending multiplier instead of the tax multiplier to calculate the output change from a $100billiontaxcut.Why:Studentsrememberthemultiplierformulabutforgetthattaxchangeshaveasmallerfirst-roundimpactbecausepartofthetaxcutissaved.Correctmove:AlwaysidentifythetypeofinitialADchangefirst:use$k = 1/(1-MPC)$forchangesinGorI,use$k_t = -MPC/(1-MPC)$ for changes in lump-sum taxes.
• Wrong move: Claiming cyclical unemployment increases after a rightward shift of AD. Why: Students mix up the inverse relationship between output and unemployment, or confuse nominal vs real output changes. Correct move: Always remember: higher real output = more workers needed = lower cyclical unemployment; lower real output = fewer workers needed = higher cyclical unemployment.
• Wrong move: Shifting LRAS along with AD in short-run analysis. Why: 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 move: Leave LRAS in its original position for short-run analysis unless the question explicitly states that potential output has changed.

6. Practice Questions (AP Macroeconomics Style)

Question 1 (Multiple Choice)

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

Worked Solution: Business investment is a component of aggregate demand, so a decline in investment causes a leftward shift of the AD curve. The economy starts at long-run equilibrium, so original output equals potential output. A leftward shift of AD intersects the unchanged SRAS at a new equilibrium with lower real output (below potential) and a lower price level. Lower output means fewer workers are needed, so cyclical unemployment rises above the natural rate. This matches option A. Correct answer: A.

Question 2 (Free Response)

An economy is initially at long-run equilibrium. A sudden increase in worker productivity reduces per-unit production costs for all firms, ceteris paribus. (a) Identify the type of shock, and state the direction of shift of the relevant curve in the short run. (2 points) (b) Explain the short-run impact of this change on equilibrium real output, the aggregate price level, and the unemployment rate. (3 points) (c) Suppose the government wants to use fiscal policy to return output back to potential after this shock. Would it use expansionary or contractionary fiscal policy, and what is one example of this policy? (2 points)

Worked Solution: (a) This is a positive (beneficial) aggregate supply shock. Higher productivity reduces production costs, so the short-run aggregate supply (SRAS) curve shifts rightward. AD and LRAS remain unchanged in the short run. (b) The new short-run equilibrium is at the intersection of the shifted SRAS and original AD. Compared to the initial long-run equilibrium: equilibrium real output increases above potential output, the aggregate price level decreases, and the unemployment rate falls below the natural rate of unemployment. (c) The government would use contractionary fiscal policy to reduce AD and shift it left to return output to potential. One example is a decrease in government spending or an increase in personal taxes.

Question 3 (Application / Real-World Style)

In 2020, the U.S. government issued stimulus checks to most households to offset income losses from the COVID-19 pandemic. The total value of the stimulus checks was $900 billion, and the MPC at the time was estimated to be 0.75. The economy was in a recession with output far below potential, so SRAS was relatively flat (little change in price level as output increased). Calculate the total expected increase in short-run equilibrium real output from this stimulus, assuming the checks acted as a lump-sum tax cut.

Worked Solution:

1. This is a change in household disposable income equivalent to a lump-sum tax cut, so we use the tax multiplier formula.
2. Calculate the tax multiplier: $k_t=-\frac{MPC}{1-MPC}=-\frac{0.75}{1-0.75}=-3$.
3. The change in "taxes" (the stimulus is equivalent to a negative tax change) is $\Delta T=-900$ billion.
4. Total change in output: $\Delta Y=k_t\times \Delta T=(-3)\times (-900)=+2700$ billion, or $2.7 trillion. In context, the stimulus checks were expected to increase short-run U.S. output by $2.7 trillion, closing a large portion of the recessionary gap created by the pandemic.

7. Quick Reference Cheatsheet

8. 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 chapter is non-negotiable for higher-scoring FRQ responses.

Long-Run Adjustment in the AD-AS Model Fiscal Policy Monetary Policy Stabilization Policy