9 AS / AD basics
The Keynesian cross holds the price level fixed. AS / AD adds P as an endogenous outcome.
9.1 What shifts AD (aggregate demand)
| change | effect on AD |
|---|---|
| \uparrow \overline{G} | shifts right |
| \downarrow \overline{T} | shifts right |
| \uparrow M^S | shifts right (lower r → more I^d) |
| \uparrow wealth | shifts right |
| \uparrow exports | shifts right |
| Currency depreciation | shifts right (\uparrow X, \downarrow M) |
9.2 What shifts AS (aggregate supply)
| change | effect on AS |
|---|---|
| Productivity rises | shifts right (more output at every P) |
| Input costs fall | shifts right |
| Cost-push shock (oil, war, supply chain) | shifts left |
| Expected P rises | shifts left |
9.3 Putting it together
A demand shock (\uparrow G, depreciation, OMO purchase) shifts AD right. Both Y and P rise.
A supply shock (oil price spike) shifts AS left. Y falls, P rises. This is stagflation.
A productivity boom shifts AS right. Y rises, P falls.
Key trade-off. Demand shocks move Y and P in the same direction. Supply shocks move them in opposite directions. The diagnostic is the comovement.
9.4 Why this matters for fiscal/monetary policy
If the gap is from a demand shortfall (recessionary, Y < Y^{FE}, low P pressure), expansionary fiscal or monetary policy works cleanly: AD shifts right, Y rises toward Y^{FE}, modest P rise.
If the gap is from a supply shock (cost-push, Y < Y^{FE} but P already high), expansionary policy raises P further without much Y recovery. The Fed faces a real dilemma.