Unlike the aggregate demand curve, the
aggregate supply curve does not usually shift
independently. This is because the equation for the
aggregate supply curve contains no terms that are
indirectly related to either the price level or
output. Instead, the equation for aggregate supply
contains only terms derived from the AS-AD model.
For this reason, to understand how the aggregate
supply curve shifts, we must work from the AS-AD
model as a whole.

depicts the AS-AD model. The intersection of the
short-run aggregate supply curve, the long-run
aggregate supply curve, and the aggregate demand
curve gives the equilibrium price level and the
equilibrium level of output. This is the
starting point for all problems dealing with the AS-
AD model.

Shifts in Aggregate Demand in the AS-AD Model

The primary cause of shifts in the economy is
aggregate demand. Recall that aggregate demand can
be affected by consumers both domestic and foreign,
the Fed, and the government. For a review of the
shifters of aggregate demand, see the SparkNote on
aggregate demand. In
general, any expansionary policy shifts the
aggregate demand curve to the right while any
contractionary policy shifts the aggregate demand
curve to the left. In the long run, though, since
long-term aggregate supply is fixed by the factors of
production, short-term aggregate supply shifts to the
left so that the only effect of a change in aggregate
demand is a change in the price level.

Let's work through an example. For this example,
refer to .
Notice that we begin at point A where short-run
aggregate supply curve 1 meets the long-run aggregate
supply curve and aggregate demand curve 1. The point
where the short-run aggregate supply curve and the
aggregate demand curve meet is always the short-run
equilibrium. The point where the long-run aggregate
supply curve and the aggregate demand curve meet is
always the long-run equilibrium. Thus, we are in
long-run equilibrium to begin.

Now say that the Fed pursues expansionary monetary
policy. In this case, the aggregate demand curve
shifts to the right from aggregate demand curve 1 to
aggregate demand curve 2. The intersection of short-
run aggregate supply curve 1 and aggregate demand
curve 2 has now shifted to the upper right from point
A to point B. At point B, both output and the price
level have increased. This is the new short-run
equilibrium.

But, as we move to the long run, the expected price
level comes into line with the actual price level as
firms, producers, and workers adjust their
expectations. When this occurs, the short-run
aggregate supply curve shifts along the aggregate
demand curve until the long-run aggregate supply
curve, the short-run aggregate supply curve, and the
aggregate demand curve all intersect. This is
represented by point C and is the new equilibrium
where short-run aggregate supply curve 2 equals the
long-run aggregate supply curve and aggregate demand
curve 2. Thus, expansionary policy causes output and
the price level to increase in the short run, but
only the price level to increase in the long run.

The opposite case exists when the aggregate demand
curve shifts left. For example, say the Fed pursues
contractionary monetary policy. For this example,
refer to .
Notice that we begin again at point A where short-run
aggregate supply curve 1 meets the long-run aggregate
supply curve and aggregate demand curve 1. We are in
long-run equilibrium to begin.

If the Fed pursues contractionary monetary policy,
the aggregate demand curve shifts to the left from
aggregate demand curve 1 to aggregate demand curve 2.
The intersection of short-run aggregate supply curve
1 and the aggregate demand curve has now shifted to
the lower left from point A to point B. At point B,
both output and the price level have decreased. This
is the new short-run equilibrium.

But, as we move to the long run, the expected price
level comes into line with the actual price level as
firms, producers, and workers adjust their
expectations. When this occurs, the short-run
aggregate supply curve shifts down along the
aggregate demand curve until the long-run aggregate
supply curve, the short-run aggregate supply curve,
and the aggregate demand curve all intersect. This
is represented by point C and is the new equilibrium
where short-run aggregate supply curve 2 meets the
long-run aggregate supply curve and aggregate demand
curve 2. Thus, contractionary policy causes output
and the price level to decrease in the short run, but
only the price level to decrease in the long run.

This is the logic that is applied to all shifts in
aggregate demand. The long-run equilibrium is always
dictated by the intersection of the vertical long-run
aggregate supply curve and the aggregate demand
curve. The short-run equilibrium is always dictated
by the intersection of the short-run aggregate supply
curve and the aggregate demand curve. When the
aggregate demand curve shifts, the economy always
shifts from the long-run equilibrium to the short-run
equilibrium and then back to a new long-run
equilibrium. By keeping these rules and the examples
above in mind it is possible to interpret the effects
of any aggregate demand shift in both the short run
and in the long run.

Shifts in Aggregate Supply in the AS-AD Model

Shifts in the short-run aggregate supply curve are
much rarer than shifts in the aggregate demand curve.
Usually, the short-run aggregate supply curve only
shifts in response to the aggregate demand curve.
But, when a supply shock occurs, the short-run
aggregate supply curve shifts without prompting from
the aggregate demand curve. Fortunately, the
correction process is exactly the same for a shift in
the short-run aggregate supply curve as it is for a
shift in the aggregate demand curve. That is, when
the short-run aggregate supply curve shifts, a short-
run equilibrium exists where the short-run aggregate
supply curve intersects the aggregate demand curve.
Then the aggregate demand curve shifts along the
short-run aggregate supply curve until the aggregate
demand curve intersects both the short-run and the
long-run aggregate supply curves. Once the economy
reaches this new long-run equilibrium, the price
level is changed but output is not.

There are two types of supply shocks. Adverse
supply shocks include things like increases in oil
prices, a drought that destroys crops, and aggressive
union actions. In general, adverse supply shocks
cause the price level for a given amount of output to
increase. This is represented by a shift of the
short-run aggregate supply curve to the left.
Positive supply shocks include things like
decreases in oil prices or an unexpected great crop
season. In general, positive supply shocks cause the
price level for a given amount of output to decrease.
This is represented by a shift of the short-run
aggregate supply curve to the right.

Let's work through an example. For this example,
refer to .
Notice that we begin at point A where short-run
aggregate supply curve 1 meets the long-run aggregate
supply curve and aggregate demand curve 1. Thus, we
are in long-run equilibrium to begin.

Now say that a positive supply shock occurs: a
reduction in the price of oil. In this case, the
short-run aggregate supply curve shifts to the right
from short-run aggregate supply curve 1 to short-run
aggregate supply curve 2. The intersection of short-
run aggregate supply curve 2 and aggregate demand
curve 1 has now shifted to the lower right from point
A to point B. At point B, output has increased and
the price level has decreased. This is the new
short-run equilibrium.

However, as we move to the long run, aggregate demand
adjusts to the new price level and output level.
When this occurs, the aggregate demand curve shifts
along the short-run aggregate supply curve until the
long-run aggregate supply curve, the short-run
aggregate supply curve, and the aggregate demand
curve all intersect. This is represented by point C
and is the new equilibrium where short-run aggregate
supply curve 2 equals the long-run aggregate supply
curve and aggregate demand curve 2. Thus, a positive
supply shock causes output to increase and the price
level to decrease in the short run, but only the
price level to decrease in the long run.

Let's work through another example. For this
example, refer to .
Notice that we begin at point A where short-run
aggregate supply curve 1 meets the long run aggregate
supply curve and aggregate demand curve 1. Thus, we
are in long-run equilibrium to begin.

Now say that an adverse supply shock occurs: a
terrifying increase in the price of oil. In this
case, the short-run aggregate supply curve shifts to
the left from short-run aggregate supply curve 1 to
short-run aggregate supply curve 2. The intersection
of short-run aggregate supply curve 2 and aggregate
demand curve 1 has now shifted to the upper left from
point A to point B. At point B, output has decreased
and the price level has increased. This condition is
called stagflation. This is also the new short-
run equilibrium.

However, as we move to the long run, aggregate demand
adjusts to the new price level and output level.
When this occurs, the aggregate demand curve shifts
along the short-run aggregate supply curve until the
long-run aggregate supply curve, the short-run
aggregate supply curve, and the aggregate demand
curve all intersect. This is represented by point C
and is the new equilibrium where short-run aggregate
supply curve 2 equals the long-run aggregate supply
curve and aggregate demand curve 2. Thus, an adverse
supply shock causes output to decrease and the price
level to increase in the short run, but only the
price level to increase in the long run.

This is the logic that is applied to all shifts in
short-run aggregate supply. The long-run equilibrium
is always dictated by the intersection of the
vertical long run aggregate supply curve and the
aggregate demand curve. The short-run equilibrium is
always dictated by the intersection of the short-run
aggregate supply curve and the aggregate demand
curve. When the short-run aggregate supply curve
shifts, the economy always shifts from the long-run
equilibrium to the short-run equilibrium and then
back to a new long-run equilibrium. By keeping these
rules and the examples above in mind, it is possible
to interpret the effects of any short-run aggregate
supply shift, or supply shock, in both the short run
and in the long run.

Conclusions from the AS-AD Model

This section has served a number of purposes. First,
we covered how and why the short-run aggregate supply
curve shifts. Second, we reviewed how and why the
aggregate demand curve shifts. Third, we introduced
the mechanism that moves the economy from the long
run to the short run and back to the long run when
there is a change in either aggregate supply or
aggregate demand. At this stage, you have the
ability to use the highly realistic model of the
macroeconomy provided by the AS-AD diagram to analyze
the effects of macroeconomic policies. This will
prove to be the most powerful tool in your collection
for understanding the macroeconomy. Use it wisely!