How are the price level and real output determined for the whole economy?
Macroeconomic equilibrium where AD equals AS, the effects of shifts in AD and AS, and the difference between the Keynesian and classical analysis of equilibrium.
An answer to AQA A-Level Economics 4.2.3, covering macroeconomic equilibrium where AD equals AS, the effects of shifts in aggregate demand and aggregate supply on output and the price level, and the Keynesian and classical analyses.
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What this dot point is asking
AQA wants you to explain macroeconomic equilibrium where AD equals AS, analyse the effects of shifts in AD and AS on the price level and real output, and contrast the Keynesian and classical analyses. This is the central diagram of the whole macro paper, so accuracy and the conditional reasoning around it earn marks repeatedly.
Macroeconomic equilibrium
This is shown by the intersection of the AD curve and the AS curve. At this point planned spending exactly matches planned output, so there is no tendency for the price level or output to change. As in a single market, if planned demand exceeds output the price level is bid up, and if output exceeds demand it falls, restoring equilibrium.
Shifts in AD
A leftward shift of AD reduces real output and the price level (or slows their growth), opens a negative output gap, raises cyclical unemployment, and can cause a recession. The multiplier amplifies any AD shift, so the eventual change in output exceeds the initial change in spending.
Shifts in AS
A rightward shift of SRAS (lower costs, for example falling oil prices) raises output and lowers the price level in the short run. A rightward shift of LRAS represents an increase in productive potential, raising real output while reducing the price level, the ideal of non-inflationary growth that allows AD to grow without causing inflation. A leftward SRAS shift (a cost shock) produces stagflation: higher prices and lower output simultaneously.
Keynesian versus classical analysis
In the classical model, with a vertical LRAS, a rise in AD only raises prices in the long run, since output is fixed at full capacity; only supply-side policy can raise long-run output. In the Keynesian model, with an L-shaped AS, a rise in AD when there is spare capacity raises output with little effect on prices, justifying active demand-side intervention in a recession. The two models therefore give opposite policy prescriptions in a slump, which is why the AS view you adopt must be stated.
Exam-style practice questions
Practice questions written in the style of AQA exam questions on this dot point, with worked answer explainers. The year tag is the paper they imitate, not the source.
AQA 20199 marksUsing an AD and AS diagram, analyse the effect on real output and the price level of a large rise in government investment spending.Show worked answer →
A 9 mark analysis question rewards a developed chain and a diagram.
- AD shift
- Government investment is a component of AD (and crowds in private investment), so AD shifts right; the multiplier magnifies the rise.
- Effect with spare capacity
- On the flatter section of AS, real output rises substantially with little inflation, closing a negative output gap and cutting cyclical unemployment.
- Effect near capacity
- On the steep section, most of the effect is a higher price level with little extra output.
- Conclusion
- The split between output and prices depends on the slope of AS and the initial output gap. Markers reward the conditional analysis and an accurate diagram.
AQA 20219 marksAssess the view that a rise in aggregate demand is always inflationary.Show worked answer →
A 9 mark assessment question needs both cases and a judgement.
- Inflationary case
- Near full capacity (steep or vertical AS), a rightward AD shift mainly raises the price level (demand-pull inflation) with little extra output.
- Non-inflationary case
- With a large negative output gap (flat Keynesian AS), the same AD rise mainly raises real output, using spare capacity with little price effect.
- Judgement
- A rise in AD is not always inflationary; the outcome depends on the output gap and the slope of AS. Inflation is likely near capacity but not in a deep recession. Markers reward both diagrams and a conditional conclusion.
Related dot points
- The components of aggregate demand, why the AD curve slopes downwards, the determinants of consumption, investment, government spending and net trade, and the multiplier.
An answer to AQA A-Level Economics 4.2.3, covering the components of aggregate demand, why the AD curve slopes downwards, the determinants of consumption, investment, government spending and net trade, and the multiplier effect.
- Short-run and long-run aggregate supply, the determinants of each, and the difference between the Keynesian and classical views of the long-run AS curve.
An answer to AQA A-Level Economics 4.2.3, covering short-run and long-run aggregate supply, the determinants of each, and the difference between the Keynesian and classical views of the long-run AS curve.
- Actual and potential growth, the causes of growth, the phases of the economic cycle, output gaps, and the costs and benefits of economic growth.
An answer to AQA A-Level Economics 4.2.4, covering actual and potential growth, the causes of growth, the phases of the economic cycle, positive and negative output gaps, and the costs and benefits of economic growth.
- The measurement of inflation, demand-pull and cost-push causes, the consequences of inflation and deflation, and the role of expectations.
An answer to AQA A-Level Economics 4.2.5, covering the measurement of inflation using the CPI, demand-pull and cost-push causes, the consequences of inflation and deflation, and the role of expectations.
- The measurement of unemployment, the types and causes of unemployment, the consequences of unemployment, and the significance of changes in employment and the labour force.
An answer to AQA A-Level Economics 4.2.5, covering the measurement of unemployment, the types and causes of unemployment, the consequences of unemployment, and the significance of changes in employment and the labour force.
Sources & how we know this
- AQA A-level Economics (7136) specification — AQA (2015)