2.8 - Using the aggregate demand-supply
diagram to show changes in economic activity
1.1 When showing how demand side and supply side factors interact to
alter the overall level of economic activity and living standards we use an
aggregate demand-supply diagram
1.2 AD/AS diagram - used to illustrate the key sets of influences or
factors affecting spending and productive capacity on an
economy’s equilibrium level of GDP or economic activity.
1.3 looks at how the equilibrium is reached nationally across all markets and how both
demand and supply interact to determine the general level of prices.
2 Aggregate demand line
2.1 negative slope
2.2 overall quantity demanded contracts when
there is a rise in the general price level.
2.3 Lower prices cause expansion in their quantity of
national production that would be demanded.
2.4 Reasons for neg sloping line; higher prices usually eat
into the purchasing power of individuals, reducing how
much they buy. Inflation also encourages Aus to buy
cheaper imports rather than Aus products.
2.5 response to generally stronger demand side conditions is
that buyers are prepared to purchase larger quantities of
local products at all given price levels. This will cause the
whole AD line to shift up and to the right
2.6 Weaker demand side conditions move the
whole AD line down and to the left
2.7 Factors which move these lines are disposable incomes,
consumer and business confidence, overseas economic activity,
population growth, interest rates and government economic
3 Aggregate supply line
3.1 When graphed Aus supply line
traces the relationship between the
quantity of final national production that
would be made available to suppliers at
different general price levels.
3.2 line is positive and has three
sections to it.
3.2.1 1. Horizontal Section
126.96.36.199 exists at low levels of national output
or supply where there are unused
188.8.131.52.1 This is where firms would find it
easy to increase production levels
in response to little or no rise in
3.2.2 2. Upper or vertical zone
184.108.40.206 generally no unused productive capacity.
220.127.116.11.1 National production is at its limit because all
resources are fully employed.
18.104.22.168.1.1 Large rises in the price and the offer of huge profits are
not enough for an actual increase in the volume of
22.214.171.124.1.1.1 firms cannot get hold of extra resources that they would
require to lift their GDP.
3.2.3 3. Intermediate zone
126.96.36.199 between these
188.8.131.52 Indicates the gradual onset of full
employment where the little excess
capacity remaining soon gives way to no
unused capacity at all.
184.108.40.206.1 Moving upwards into this zone means price
rises are needed to make extra production and
3.3 Rising the supply line depends on the level of
unused capacity and whether there is access to
3.4 Production can sometimes be bottle necked and limited.
Firms would generally like to supply more as it means a
price rise but they cannot do this.
3.5 Over time the productive capacity changes and with it is the
position of the line. Supply side factors are responsible for this.
3.6 More favourable supply side conditions improve national
productive capacity causing the line to increase or more outwards.
3.7 less favourable supply side conditions result in a decrease in
the AS line that shifts inwards. Producers here are less willing
to produce more and capacity is cut.
4 Changes in the equilibrium level of
4.1 National economic conditions change
to reflect the levels of AD and AS
4.1.1 show a cyclical pattern
with many ups and
4.2 Sometimes stagflation can occur
4.3 The causes of all these conditions
can be illustrated on the diagrams.
changed by new
affecting the level
5.1 high or low economic activity can depend on
where the AD line crosses the AS line.
5.2 actual position of the AD line reflects the ever changing
conditions of demand affecting expenditure on Australian
5.3 Deficient AD and recession
5.3.1 Weak demand side conditions prevail, the equilibrium
level of economic activity will also be down
5.3.2 Low or falling production will cause a rise in cyclical
unemployment and perhaps a recession
5.4 Excessive AD and boom
5.4.1 Strong AD side conditions rise excessively the new equilibrium will
cause economic activity to rise to a higher GDP.
220.127.116.11 Soaring production is present here, the problem is inflation and a boom
5.4.2 excessive spending, production cannot
keep up and the economy overheats.
18.104.22.168 Shortages occur, causing a
rise of prices and demand
5.5 Ideal AD and
5.5.1 AD conditions are at
5.5.3 role of AD in this ideal
situation is to help
decide the national
level of economic
activity. This does not
account for the
situation of stagflation
5.5.4 AD doesn't
impact in the long
term as much as
AS so therefore
we turn to the
6 Equilibrium changed by
new conditions affecting AS
of the AS
fixed. In the
this is not
6.2 Favourable supply conditions
6.2.1 favourable ~ producers
keen to increase
production and capacity
there will be a rise in
quantity supplied at all
prices and the whole
AS line will shift
6.2.2 new equilibrium with be
a result of an increase
in AS which means
there has been a rise in
national output and
employment in GDP.
22.214.171.124 fall in price
The rise in the
AS lines there
6.3.1 unfavourable~producers are less willing to
expand capacity or supply goods and
services, supply would fall as would
production, employment and GDP.
6.3.2 Rising production costs or falling
profits force firms to lift their
prices, accelerating inflation.
126.96.36.199 stagflation occurs. The solution to this
problem is to implement government policies
to improve the supply side conditions.
7 Application of
this model for
7.1 gov aim is to make society better of and stabilise our economic activity
7.2 two approaches used by the federal government to grow economic activity over time
7.2.1 Aggregate demand or
and Aggregate supply
7.3 1. Aggregate demand or
7.3.1 Try to steer the level of economic activity to maximise living standards
7.3.2 AD needs to be controlled so that it isn't too strong or too weak.
7.3.3 We don’t want it to cause booms and recessions
7.4 2. Aggregate supply policies
7.4.1 includes microeconomic reforms, immigration, aspects of the budget and environment factors.
7.4.2 often wish to increase AS, efficiency and productive
capacity needed to be economically stable.
7.4.3 impact of these two types of policies on economic activity can also be shown using the AD-AS diagram.