The flagship macro diagram: demand shocks, supply shocks, and the short-run vs. long-run distinction.
Warming up the engine…
The whole-economy version of supply and demand: aggregate demand (total spending at each price level) meets short-run aggregate supply to determine real output and the price level together.
AD: Y = C + I + G + NX (falls as P rises) ; SRAS slopes up ; LRAS vertical at potential output Y*
Demand shocks (stimulus, confidence, rate cuts) move output and prices the SAME direction; supply shocks (oil, wages, drought) move them in OPPOSITE directions, which is why stagflation is the tell-tale sign of a supply problem. In the long run wages adjust, SRAS shifts back, and only prices remain changed.
State which curve shifts, which way, and what happens to BOTH output and the price level. A demand-shock answer that forgets the price level, or a supply-shock answer that has prices and output moving together, loses the marks.
Now prove you have it
Move the curve to where you think it lands, and get told exactly which part you got right.
Real-world scenarios on this model
Equilibrium at Y 53, P 42.
Equilibrium: Y* = 53.1, P* = 42.2
Current equations
The whole economy in one diagram. AD shows total spending at each price level; SRASSRASShort-run aggregate supply: what firms produce at each price level while wages and input costs are still sticky. shows what firms produce in the short run; the vertical LRASLRASLong-run aggregate supply: the economy's potential output, fixed by resources and technology, independent of the price level. marks potential outputpotential outputThe output an economy can sustain with normal use of its resources, where it returns once prices fully adjust., what the economy can sustain. Demand shocks move output and prices the same direction; supply shocks move them opposite ways.
Source: Mankiw, Macroeconomics, ch. 10-14; Blanchard ch. 7