What this lesson teaches
I can use AD and AS to find the equilibrium national output and general price level.
Syllabus 8843, 3.1.1(d). Aggregate Demand and Aggregate Supply: How interaction of AD and AS determines equilibrium level of national output and general price level
Make a guess
World oil prices double. What happens to Singapore's real output and price level?
- Prices rise but output stays the same.
- Both rise, because oil firms earn more.
- Prices rise and real output falls.
Show the answer
Prices rise and real output falls.
Oil is an input for most firms, so costs rise and SRAS shifts up. That is cost-push inflation, with lower output.
A rise in costs shifts AS up, so prices rise and real output falls at the same time.
A supply shock changes firms' costs or their ability to produce.
An adverse supply shock, such as a jump in oil prices or a disruption to supply chains, raises costs at every level of output. Short-run AS (SRAS) shifts up.
With AD unchanged, the price level rises and real output falls. This is cost-push inflation, and it creates a painful trade-off: higher prices and lower output together.
Singapore imports almost all its energy and most of its food, so it is very exposed to global supply shocks.
- Adverse shock
- SRAS up: prices rise, output falls.
- Favourable shock
- SRAS down: prices fall, output rises.
| AD | SRAS | Price level | Real output |
|---|---|---|---|
| Rises | Shifts up (costs rise) | Rises | Depends on sizes |
| Falls | Shifts down (costs fall) | Falls | Depends on sizes |
| Rises | Shifts down | Depends on sizes | Rises |
| Falls | Shifts up | Depends on sizes | Falls |
Worked example: Energy prices and stronger exports together
Global energy prices rise, while demand for Singapore's exports also strengthens.
- Energy costs: SRAS shifts up, raising prices and lowering output.
- Stronger exports: AD shifts right, raising prices and output.
- Both push prices up, so the price level certainly rises.
- Output could rise or fall, depending on which shock is bigger.
Watch out for this
An oil price rise increases real output because firms earn more.
Most firms buy oil as an input, so their costs rise. SRAS shifts up, and real output falls.
Check your understanding
New software lifts productivity across many industries. How do the economy's output and general prices respond?
- Output rises, and prices fall or rise more slowly.
- Prices rise, because firms must pay for the software.
- Output falls, because firms need fewer workers.
Show the answer
Output rises, and prices fall or rise more slowly.
Right. Lower costs per unit shift AS right, so more is produced at each price level.