AP_Krugman_Textbook

in government purchases during World War II. In 2008, the U.S. econ-

omy experienced another significant negative demand shock as the

housing market turned from boom to bust, leading consumers and

firms to scale back their spending.

Figure 19.2 shows the short -run effects of negative and positive de-

mand shocks. A negative demand shock shifts the aggregate demand

curve, AD,to the left, from AD 1 toAD 2 , as shown in panel (a). The

economy moves down along the SRAScurve from E 1 toE 2 , leading to

lower short-run equilibrium aggregate output and a lower short-run

equilibrium aggregate price level. A positive demand shock shifts the

aggregate demand curve, AD,to the right, as shown in panel (b). Here,

the economy moves up along the SRAScurve, from E 1 toE 2. This leads

to higher short-run equilibrium aggregate output and a higher short-

run equilibrium aggregate price level. Demand shocks cause aggregate

output and the aggregate price level to move in the same direction.

Shifts of the SRASCurve

An event that shifts the short -run aggregate supply curve, such as a change in com-

modity prices, nominal wages, or productivity, is known as a supply shock.Anegative

supply shock raises production costs and reduces the quantity producers are willing to

supply at any given aggregate price level, leading to a leftward shift of the short -run ag-

gregate supply curve. The U.S. economy experienced severe negative supply shocks fol-

lowing disruptions to world oil supplies in 1973 and 1979. In contrast, a positivesupply

shock reduces production costs and increases the quantity supplied at any given aggre-

gate price level, leading to a rightward shift of the short -run aggregate supply curve.

The United States experienced a positive supply shock between 1995 and 2000, when

the increasing use of the Internet and other information technologies caused produc-

tivity growth to surge.

192 section 4 National Income and Price Determination

© Bettmann/CORBIS

Aggregate

price

level

Y 2 Y 1 Real GDP

E 1

E 2

SRAS

AD 1

...leads to a lower

aggregate price

level and lower

aggregate output.

A negative

demand shock...

Aggregate

price

level

Y 1 Y 2 Real GDP

E 2

E 1

SRAS

AD 2

...leads to a higher

aggregate price

level and higher

aggregate output.

A positive

demand shock...

(a) A Negative Demand Shock (b) A Positive Demand Shock

AD 2 AD 1

P 1

P 2

P 2

P 1

figure 19.2 Demand Shocks

A demand shock shifts the aggregate demand curve, moving the ag-

gregate price level and aggregate output in the same direction. In

panel (a), a negative demand shock shifts the aggregate demand

curve leftward from AD 1 toAD 2 , reducing the aggregate price level

fromP 1 toP 2 and aggregate output from Y 1 toY 2. In panel (b), a

positive demand shock shifts the aggregate demand curve right-

ward, increasing the aggregate price level from P 1 toP 2 and aggre-

gate output from Y 1 toY 2.

An event that shifts the short -run aggregate

supply curve is a supply shock.