Aggregate demand and aggregate supply, short-run and long-run equilibrium, demand-side and supply-side shocks, and inflationary and deflationary effects.
AD is the total planned expenditure on an economy's final goods and services at each general price level:
AD=C+I+G+(X−M)
The AD curve slopes downwards. It shifts right when any component rises for reasons other than the price level, e.g. higher consumer confidence, lower interest rates, more government spending, lower taxes, or higher exports.
Aggregate supply
Short-run aggregate supply (SRAS) slopes upwards: input prices such as wages adjust slowly, so a higher price level raises output.
Long-run aggregate supply (LRAS) is vertical at the full-employment output, which depends on the quantity and quality of resources and technology.
SRAS shifts left when production costs rise (wage rates, oil prices, rents).
LRAS shifts right with more resources (a larger labour force, more capital) or better technology.
Equilibrium
Short run: where AD intersects SRAS.
Long run: where AD, SRAS and LRAS meet. In the long run a change in AD changes only the price level; real output returns to the full-employment level.
Demand-side and supply-side shocks
Shock
Curve
Price level
Real output
Unemployment
AD rises
AD shifts right
↑
↑ (short run)
↓
AD falls
AD shifts left
↓
↓ (short run)
↑
Production costs rise
SRAS shifts left
↑
↓
↑
Productive capacity rises
LRAS (and SRAS) shift right
↓
↑
A rising price level together with falling output is called stagflation.
Common mistake: a change in the general price level is a movement along the AD curve, not a shift.
In the DSE exam
Syllabus scope
You need: the components of AD and what shifts it, the shapes of SRAS and LRAS and what shifts them, short-run and long-run equilibrium, and the effects of demand-side and supply-side shocks on the price level, real output and unemployment.
Not needed: the Keynesian multiplier calculation or a detailed derivation of why the AD curve slopes downward.
How it is tested
MC: "Which of the following will shift Hong Kong's AD curve to the right?" / pick the diagram that shows a given shock.
Diagram questions (4 to 6 marks): "With the aid of an AD-AS diagram, explain the short-run effect of ... on the general price level and real output."
How to answer
Name the component or cost that changes and the curve it shifts: "Exports rise → AD increases (shifts right)." (1)
Draw a labelled AD-AS diagram: axes (general price level, real output), the original and new curves, and the two equilibrium points. (1 to 2)
State the effects on the price level, real output and, if asked, unemployment. (1 to 2)