Graph walkthrough · Macro · Aggregate demand and aggregate supply

A stock market crash

Share prices fall by a third in a month.

Step 1 of 3 · Before the crash

The economy is at potential output. Real GDP is on the horizontal axis and the price level on the vertical. E₀ sits on LRAS.

The chain in words

Step 1
Before the crash
The economy is at potential output. Real GDP is on the horizontal axis and the price level on the vertical. E₀ sits on LRAS.
Step 2
Aggregate demand shifts left
Households feel poorer when their savings shrink, and they spend less at every price level. This is the wealth effect. Aggregate demand shifts left. Firms cut output and prices, and the economy moves to E₁, below potential.
Step 3
The slow return
Left alone, the recession pushes wages down over time. Lower costs shift SRAS right, and the economy returns to E₂ on LRAS at a lower price level.

Takeaway. A fall in wealth cuts consumption and shifts AD left: output and prices fall in the short run.

Draw it yourself

This shock: draw the graph Consumer confidence collapses Government sends stimulus checks An oil price spike

More on the aggregate demand and aggregate supply graph

Confidence collapses Stimulus closes a recessionary gap An oil shock brings stagflation A housing boom overheats The central bank cools an overheating economy Technology raises potential output An export boom Expected inflation moves supply Austerity cuts demand

Go deeper

Lesson: Aggregate Demand

The walkthrough shows the chain. The lesson explains why each link holds, with worked examples and practice questions that remember what you get wrong.

Read the lesson Start the course