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What determines aggregate demand and supply, and how do they set the price level and national output?

Aggregate demand and aggregate supply: the components of aggregate demand, the determinants of short-run and long-run aggregate supply, macroeconomic equilibrium, and the effects of shifts in AD and AS.

An Eduqas A520 answer to the AD-AS model, covering the four components of aggregate demand and what shifts them, the determinants of short-run and long-run aggregate supply, macroeconomic equilibrium, and how shifts in aggregate demand and supply affect the price level and real national output.

Generated by Claude Opus 4.813 min answerUpdated 2026-06-02

Reviewed by: AI editorial process; not yet individually human-reviewed

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Quick answer

Aggregate demand (AD) is the total planned spending on an economy's output at each price level: $AD = C + I + G + (X - M)$ , made up of consumption, investment, government spending and net exports. The AD curve slopes downward and shifts when any component changes. Short-run aggregate supply (SRAS) shows output supplied at each price level when input prices (wages) are fixed; it slopes upward and shifts with costs of production. Long-run aggregate supply (LRAS) shows the economy's productive capacity (potential output); it is vertical (or upward-sloping in the Keynesian model) and shifts with the quantity and quality of factors of production. Macroeconomic equilibrium is where AD equals AS, setting the price level and real output. A rightward shift of AD raises output and the price level (more so near capacity); a rightward shift of AS raises output and lowers the price level.

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What this dot point is asking
Aggregate demand and its components
Aggregate supply: short run and long run
Macroeconomic equilibrium and shifts
Examples in context
Try this

What this dot point is asking

Eduqas wants you to identify the components of aggregate demand and what shifts each, explain the determinants of short-run and long-run aggregate supply, find macroeconomic equilibrium, and analyse the effects of shifts in AD and AS on the price level and real output. The AD-AS model is the central framework for the whole of macroeconomic policy.

Aggregate demand and its components

Each component is shifted by its own determinants: consumption by disposable income, confidence, interest rates and wealth; investment by interest rates, expected profit, confidence ("animal spirits") and the accelerator; government spending by fiscal policy; and net exports by the exchange rate, relative competitiveness and world income.

Aggregate supply: short run and long run

Key fact

Short-run aggregate supply (SRAS) shows the total output firms supply at each price level when the prices of inputs (especially wages) are fixed. It slopes upward: a higher price level, with costs fixed, raises profit margins and output. SRAS shifts with the costs of production (wages, raw materials, energy, exchange-rate-driven import prices and indirect taxes): a cost rise shifts SRAS left. Long-run aggregate supply (LRAS) shows the economy's productive potential when all input prices have adjusted. In the classical view LRAS is vertical at the full-capacity level of output; in the Keynesian view it is L-shaped (horizontal with spare capacity, then vertical at full capacity). LRAS shifts right (long-run growth) when the quantity or quality of factors of production rises: more or better labour, capital, technology and productivity.

Macroeconomic equilibrium and shifts

The effects of shifts depend on which curve moves and the slope of AS:

A rightward shift of AD (higher C, I, G or net exports) raises real output and the price level. Near full capacity the effect is mostly on the price level (inflation); with spare capacity it is mostly on output.
A leftward shift of AD lowers output and the price level (recession, possible deflation).
A rightward shift of SRAS (lower costs) raises output and lowers the price level; a leftward shift (higher costs) causes cost-push inflation and lower output (stagflation).
A rightward shift of LRAS raises potential output (long-run growth) and eases inflationary pressure.

Tracing a demand-side and a supply-side shift

Step 1: a rise in aggregate demand

Suppose investment and government spending both rise. AD shifts right. With the economy below full capacity (on the upward-sloping part of SRAS), real output rises (say from $\pounds 500$ bn to $\pounds 540$ bn) and the price level rises modestly.

Step 2: approaching capacity

If AD keeps rising as the economy nears the LRAS (full-capacity) level, further rightward AD shifts raise the price level sharply with little extra output: demand-pull inflation dominates.

Step 3: a supply-side improvement

Now suppose a successful supply-side policy raises productivity, shifting LRAS right (potential output rises to $\pounds 580$ bn). The economy can now produce more without inflationary pressure.

Step 4: interpret

Demand-side shifts move output and prices along the existing supply curve; supply-side improvements raise the economy's capacity, allowing non-inflationary growth. This is why the AD-AS model frames the whole debate between demand-side and supply-side policy.

Examples in context

Pandemic stimulus. Large rises in government spending shifted AD right to offset a demand collapse, the textbook demand-side response.
The 2022 energy shock. A surge in input costs shifted SRAS left, causing stagflation (higher prices, weaker output).
Long-run investment. Sustained investment in skills and infrastructure shifts LRAS right, raising potential output over time.

Try this

Q1. Explain two factors that could shift the aggregate demand curve to the right. [4 marks]

Cue. Any two of: higher consumption (lower interest rates, higher confidence), higher investment, higher government spending, or higher net exports (a weaker exchange rate).

Q2. Using an AD-AS diagram, explain the effect of a fall in business confidence on output and the price level. [4 marks]

Cue. Lower investment (and consumption) shifts AD left, reducing real output and the price level, with the size depending on the slope of AS.

Exam-style practice questions

Practice questions written in the style of WJEC Eduqas exam questions on this dot point, with worked answer explainers. The year tag is the paper they imitate, not the source.

Eduqas Component 1 20192 marksState the four components of aggregate demand.

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A 2-mark knowledge question. Award the marks for identifying the components of aggregate demand.

Aggregate demand is $AD = C + I + G + (X - M)$ : consumption (C), investment (I), government spending (G), and net exports (exports X minus imports M).

Markers reward all four (consumption, investment, government spending and net exports). Writing the formula earns full marks; listing only some components scores proportionally.

Eduqas Component 3 (macro) 202112 marksEvaluate the likely effects on the price level and real output of a large increase in business investment.

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A levels-of-response essay. Knowledge and application: investment is a component of aggregate demand, so a rise in investment shifts AD to the right. Draw an AD-AS diagram showing the rightward AD shift, raising both the price level and real output (the size of the output effect depending on the slope of AS).

Analysis: develop the multiplier effect (the initial investment raises incomes and induces further consumption) and note that investment also raises long-run aggregate supply over time (more capital), shifting LRAS right and raising potential output.

Evaluation: weigh that the effect on output is larger when there is spare capacity (a flat SRAS) and mostly inflationary near full capacity (a steep SRAS), that the multiplier depends on leakages, and that crowding out or weak confidence could limit the effect. Conclude with a supported judgement.

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Sources & how we know this

Eduqas A Level Economics Specification (A520) — Eduqas (2015)