AD-AS Model: Shifts in Aggregate Demand - Video Tutorials & Practice Problems

Equilibrium and Shifts in Aggregate Demand

So now let's see what happens with the equilibrium in the short run and the long run, when we have a shift in our aggregate demand. So when we're shifting aggregate demand, we're always gonna follow a three step process. The first thing is that our our aggregate demand is gonna shift right? The first thing is that the problem is going to tell you something that affects aggregate demand and we have to decide was it a good thing that's gonna shift it to the right or a bad thing? That's gonna shift it to the left, right, and that's very similar to what you're used to from supply and demand, shifting curves, looking for equilibrium, all of that good stuff. Right? So that's the first thing we're gonna do next. We're gonna find the short run equilibrium. So first is shift aggregate demand, next is short run equilibrium. And then third, and remember we already saw how to find our short run equilibrium, we're gonna shift that aggregate demand and we're gonna see where that new aggregate demand curve intersects with our short run aggregate supply. So that will be our short run equilibrium. And then third, we're gonna shift an opposite shift occurs in short run aggregate supply. And this is the economy adjusting for this short run equilibrium, that's not the long run equilibrium. So we're gonna see what that looks like on the graph. But note that this third step doesn't happen immediately, it doesn't happen immediately, it takes time for this third step to occur. But when we're looking at it on the graph, what we're looking for is what's the short run equilibrium gonna be And what's the new long run equilibrium after this shift. Okay. And what we're what we're going to note is that the short run aggregate supply is going to shift to find our new long run equilibrium. Okay, So it's easier to see this in in an example, but the three step process is first shifting the aggregate demand. Second, we find our new short run equilibrium and third, we get our new long run equilibrium with a shift in short run aggregate supply. Alright, so let's start here with a decrease in aggregate demand. And this is something like when we have a recession or cyclical unemployment, right? We're going to see that a decrease in aggregate demand. Well, what causes that decrease? It leads into a recession and into cyclical unemployment, right? There's less demand. So let's go ahead and see what happens here. A decrease in expected future profit has led to decreased investment spending. So this is the key here, decreased investment spending is going to affect our short run. Our short, excuse me, our aggregate demand curve. Right? So let's go ahead and draw here on the graph. Remember we've got our price level, oops, and our real GDP over here. So the key here is that there's decreased investment spending. And remember aggregate demand is made up of the consumption, investment spending, government purchases, and net exports. So if there's decreased investment spending? Well, there's there's gonna be decreased um aggregate demand. So let's go ahead and draw this in. Let's draw our original situation. So here we go. Which one's aggregate demand here? Remember we got our downward demand double Ds short run aggregate supply and long run aggregate supply. Okay, So I'm gonna put A D. One because we're shifting our aggregate demand curve. So what I'm gonna do now is I'm gonna draw our new aggregate demand curve to the left, right. We're gonna shift it to the left because we have a decrease in our aggregate demand. And I'm gonna draw it down here. Well, first, actually, I want to show you where our long run equilibrium was initially right right here was our initial price level, right? I'll say price level one. Okay, And now we're gonna shift to the left, so if we shift our aggregate demand curve to the left to a D to well, what's gonna happen here? Where's our new short run equilibrium? So right here is short run equilibrium. Right? This this point right here, where our new aggregate demand curve is touching the short run aggregate supply curve. So this decrease in investment spending has caused the aggregate demand to shift to the left, leading to a lower price level. In the short run, right, there's a lower price level and this was our original GDP right here when we were in long run equilibrium. And now we've got this GDP right here, a lower GDP because of this decrease in aggregate demand. Okay, so this is steps one and two. Step one. We shifted the aggregate demand to the left, Step two, we found our new equilibrium right, and we're able to analyze what happens what happened here. We had a decrease in the price level in the short run equilibrium and a decrease in our equilibrium G. D. P in the short run as well. So step three is going to be our aggregate supply um reacting our aggregate supply is going to react to the short run shift here to get us back to a long run equilibrium. So what we're gonna do is we're gonna shift our short run aggregate supply curve the opposite way. Okay, so if our aggregate demand had shifted to the left, our aggregate supply is going to shift to the right. Okay, so short run aggregate supply, which this was aggregate supply one, we're gonna draw a new short run aggregate supply going to the right because aggregate demand went to the left, aggregate supply is gonna go to the right. So what you wanna do this is the key point right here, this is where you want to shift it to to get it back into a long run equilibrium, right? Because we're looking for a new star shape, Remember our long run equilibrium had the X with the straight line going up right? The long run star shaped equilibrium. So our new long run equilibrium is going to pass through this point where our new aggregate demand, the red line is going to be touching the long run aggregate supply, that's not shifting. Cool. Alright, so let's go ahead and draw that in here. So this would be our short run aggregate supply, shifting to the right to meet that new long run equilibrium short run aggregate supply to Okay, so this doesn't happen immediately. Like I said, this short run aggregate demand shifted to the left and over time this aggregate supply is gonna shift to the right to um to adjust for this. So here is our new long run equilibrium. I'm gonna do it here in green right here, new long run equilibrium. Okay, new long run equilibrium right there. And what is this new long run equilibrium? What is affected? We've got we've gotten back to the same level of long run GDP, right? And remember that's always based on the factors of production um in the economy, but where do we end up is with a lower price level? So the lower price level. So what happened here, we have in the short run, I'm gonna do it in the short run, lower price, lower price level, lower GDP. And then in the long run we're back to we have a lower price level equal GDP, right? Because we're back to our long run GDP. Okay, so this this is an extra step than what we're used to when we are shifting curves in our market demand and supply, but it's not so crazy. All we're doing is we're having an opposite shift in our short run aggregate supply. The short run aggregate supply is always gonna be the one that adjusts back to our long run equilibrium. Okay, so let's go ahead and pause here and then let's talk about an increase in aggregate demand in the

Equilibrium and Shifts in Aggregate Demand

So now let's see what an increase in aggregate demand does we call this demand pull inflation? You'll see why when we get into it? We're gonna see that the prices are going to be going up with this increase in aggregate demand. Okay. It's gonna shift leading to higher long run equilibrium price. Okay. So let's go ahead and get down to the graph and let's see how a shift in our aggregate demand to the right is going to affect our long run equilibrium. So in this example we're saying there's an increase in defendant defense spending by the government. Okay, So there's an increase in government purchases. And remember government purchases are a part of our aggregate demand, right? We have consumption investment, government spending and net exports. So if the government spending is going up, our aggregate demand is going to shift to the right. So let's go ahead and start with our star shaped equilibrium for the for the original situation. Right? And you're gonna notice this is how a lot of these go. We're just gonna start with an equilibrium and see what happens when we shift. So here's our downward demand, double Ds short run aggregate supply and long run aggregate supply. Okay, So here's our original equilibrium right here where we have this price level price level one and G. D. P one, right? Our long run GDP equilibrium. And now we're gonna shift our aggregate demand to the right so our increase in defense spending by the government is going to shift our aggregate demand to the right and we're gonna have a new aggregate demand curve. Somewhere out here. Okay, aggregate demand. So this was aggregate demand one, here's aggregate demand two. Okay, so where's our short run equilibrium gonna be? Can you guys find it? Well, it's where our new aggregate demand curve touches our short run aggregate supply curve. That's going to be right here, where the red line crosses the short run aggregate supply curve, right at this point right here, this is our short run equilibrium short run up with EQ, short run equilibrium for our short run, uh equilibrium right there. So what's happened to the price level in the short run, this shift in aggregate demand is going to increase our prices right? There's more demand for for everything available in the for all the goods and services available. So it's gonna push the prices up and that's why we call it the demand pull inflation, The demand is pulling those prices up in this situation, leading to a higher level of GDP and notice what's happening at this point. This GDP is beyond our long run equilibrium. How is that even possible? Well, the trick here is that it shouldn't be possible, but what's happening is that there's over employment in the economy, there's over use of our resources. That's actually leading to what we call a hot economy were actually passed our long run equilibrium for a short period of time here, in this short run, What we're seeing is that there's over employment. Maybe people are working, there's a little bit higher wages or something, causing people to work, more businesses are seeing more profit and they're able to justify having this higher higher than normal uh GDP beyond our potential GDP in the long run. Okay, so in the short run we're able to push the price level up and the G. D. P past our long run equilibrium there. Alright, so now that we found our short run equilibrium, what did we say was gonna happen? The final step is that the short run aggregate supply is going to react to get us back to our long run equilibrium. So in this case our aggregate demand has shifted to the right. What's gonna happen with our short run aggregate supply? It's gonna shift to the left right. So now we're gonna draw a new short run aggregate supply where this was our first short run aggregate supply, Let's draw a new one. And remember we're gonna be keeping our long run aggregate supply constant in these examples. So we're looking to find our this point right here, that is going to be our new long run equilibrium where our aggregate demand curve is touching that long run equilibrium. So what we're gonna do is we're gonna draw a new short run aggregate supply to the left here, that goes through that point and draw it a little better, just like that, and that's going to be our new short run aggregate supply, that this, remember. It takes a little time for this shift to occur for it to adjust back into our long run equilibrium. So now we've reached our long run equilibrium up here. Long run equilibrium. And what's happened to the price because of this increase in aggregate demand? What? We've have another increase in the price and our long run equilibrium has a higher price level at the same long run GDP here. Okay, so what's happened here in the short run, we had a higher price, higher GDP, right, we were able to push past our long run equilibrium G. D. P. And in the long run, what's happening here? The price increases again. Higher price back to our stable amount of long run GDP there. Okay, so we're back to this G D P R long run equilibrium, G D P G D P one in this situation. Cool. So notice this isn't too too tough. We're following that three step process first. We're gonna shift the aggregate demand, either left or right, we're gonna find our new equilibrium in the short run and then we're going to shift the short run aggregate supply the opposite way from the aggregate demand. Alright, let's pause here and let's move on