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The AS/AD model and economic growth

Covers AS91224

The same model, a harder question

The AS/AD model works exactly as it does in AS91222 — but here the focus is real GDP (Y) rather than the price level, and the exam usually shifts both curves at once.
Question stems in this standard read: "Explain each shift (aggregate supply and aggregate demand curves) shown in Graph One, and the impact on economic growth."

What raises economic growth on this model

A rightward shift of AD — more spending $AD = C + I + G + (X - M)$

Rising consumer confidence, tax cuts or lower interest rates → $C$ rises
Business confidence or cheaper borrowing → $I$ rises
Infrastructure or service spending → $G$ rises
Higher export receipts or a depreciation → $(X - M)$ rises
Effect: real GDP rises and the price level rises.

A rightward shift of AS — cheaper or greater production

New technology, better skills, cheaper inputs, more infrastructure
Effect: real GDP rises and the price level falls.

Why both curves often shift together

Many real events change both spending and capacity, and the exam picks those deliberately.

Event	AD effect	AS effect
A major infrastructure project	Right — G rises during construction	Right — the finished asset raises productive capacity
A large increase in migrant workers	Right — more households consuming	Right — a larger workforce raises capacity
New capital investment by firms	Right — I rises now	Right — new machinery raises capacity later
A fall in the number of workers	Left — fewer households spending	Left — smaller workforce, less capacity
Better education and training	Little immediate effect	Right — more productive workers

Reading a both-curves diagram

When AD and AS both shift right:
- Real GDP rises strongly — both shifts push Y the same way.
- The price level barely moves — AD pushes PL up, AS pushes PL down, so they largely cancel.
This is the best possible outcome: strong growth with little inflation. Say so.
When AD and AS both shift left: real GDP falls sharply, and the price level is ambiguous.

Short run and long run

Many growth events have opposite effects over different time horizons, and saying so is a strong Merit or Excellence move.
Buying an expensive new asset: the purchase reduces short-term spending on other things — or, if the asset is imported, raises $M$ and reduces net exports — so AD falls in the short run. Operating the asset later raises capacity and consumption, so both curves shift right in the long run.
Government spending funded by higher taxes: $G$ rises but $C$ falls, so the short-run AD effect is small; the infrastructure built raises capacity in the long run.

Tips and Tricks

"Correctly stated the formula for aggregate demand" is a 2025 Achieved bullet. Write $AD = C + I + G + (X - M)$ at the top of your answer and name the component that changes. It is a free mark and it structures everything that follows.

When the graph shows both curves shifted, explain each shift separately with its own cause, then combine. The question wording — "explain each shift... and the impact on economic growth" — is telling you it wants three things: the AD reason, the AS reason, and the effect on Y.

Say what happens to the price level, even when the question is about growth. When both curves shift right, PL barely changes, and noticing that is exactly the kind of integration Excellence rewards.

Watch for events that shift a curve the opposite way to your first instinct. Buying an imported capital asset raises $M$ , which reduces $(X - M)$ and shifts AD left in the short run — even though everyone thinks of investment as expansionary. Read what the money is actually spent on and where it goes.

Worked ExampleBoth curves, two time horizons

A New Zealand airline purchases a fleet of new, more fuel-efficient aircraft from an overseas manufacturer. The aircraft are delivered and put into service the following year.

(a) Use the aggregate demand formula to explain why the purchase decreases short-term aggregate demand. (b) Explain the long-term impact of operating the new aircraft on aggregate supply and on economic growth.

Step 1 — (a) Start with the formula

$AD = C + I + G + (X - M)$

The aircraft are bought from an overseas manufacturer, so the purchase is an import.

Step 2 — Identify the component that changes

$M \text{ (import payments) rises}$

Because $M$ is subtracted in the formula, a rise in $M$ reduces net exports $(X - M)$ and therefore reduces AD.

AD shifts left in the short run.

The money leaves the New Zealand circular flow as an import payment to the overseas sector, so it does not become income for New Zealand households or revenue for New Zealand producers. On the circular flow model this is a leakage.

Step 3 — (b) The long-term effect on aggregate supply

Once the aircraft are in service, they are more fuel-efficient than the fleet they replace. Fuel is one of an airline's largest costs, so its cost of production falls — it can fly the same routes for less.

Lower costs mean the airline is willing to supply more at every price level.

AS shifts right, from AS to AS₁.

Step 4 — The effect on economic growth

Reading the new equilibrium where AS₁ cuts AD:

Real GDP rises from Y to Y₁ — this is the economic growth.
The price level falls from PL to PL₁ — cheaper production means lower airfares.

Step 5 — The second-round effect on AD

Lower airfares mean New Zealanders and overseas visitors fly more.

More overseas visitors means higher export receipts ( $X$ ), raising $(X - M)$ .
Cheaper domestic travel raises consumption ( $C$ ) on tourism and hospitality.

So AD shifts right in the long run too — and with both curves shifting right, real GDP rises strongly while the price level changes little.

$\text{Short run: } M \uparrow \Rightarrow AD \leftarrow \qquad \text{Long run: } AS \rightarrow \text{ and } AD \rightarrow \Rightarrow Y \uparrow\uparrow$

The AS/AD model and economic growth

Covers AS91224

The same model, a harder question

The AS/AD model works exactly as it does in AS91222 — but here the focus is real GDP (Y) rather than the price level, and the exam usually shifts both curves at once.
Question stems in this standard read: "Explain each shift (aggregate supply and aggregate demand curves) shown in Graph One, and the impact on economic growth."

What raises economic growth on this model

A rightward shift of AD — more spending $AD = C + I + G + (X - M)$

Rising consumer confidence, tax cuts or lower interest rates → $C$ rises
Business confidence or cheaper borrowing → $I$ rises
Infrastructure or service spending → $G$ rises
Higher export receipts or a depreciation → $(X - M)$ rises
Effect: real GDP rises and the price level rises.

A rightward shift of AS — cheaper or greater production

New technology, better skills, cheaper inputs, more infrastructure
Effect: real GDP rises and the price level falls.

Why both curves often shift together

Many real events change both spending and capacity, and the exam picks those deliberately.

Event	AD effect	AS effect
A major infrastructure project	Right — G rises during construction	Right — the finished asset raises productive capacity
A large increase in migrant workers	Right — more households consuming	Right — a larger workforce raises capacity
New capital investment by firms	Right — I rises now	Right — new machinery raises capacity later
A fall in the number of workers	Left — fewer households spending	Left — smaller workforce, less capacity
Better education and training	Little immediate effect	Right — more productive workers

Reading a both-curves diagram

When AD and AS both shift right:
- Real GDP rises strongly — both shifts push Y the same way.
- The price level barely moves — AD pushes PL up, AS pushes PL down, so they largely cancel.
This is the best possible outcome: strong growth with little inflation. Say so.
When AD and AS both shift left: real GDP falls sharply, and the price level is ambiguous.

Short run and long run

Many growth events have opposite effects over different time horizons, and saying so is a strong Merit or Excellence move.
Buying an expensive new asset: the purchase reduces short-term spending on other things — or, if the asset is imported, raises $M$ and reduces net exports — so AD falls in the short run. Operating the asset later raises capacity and consumption, so both curves shift right in the long run.
Government spending funded by higher taxes: $G$ rises but $C$ falls, so the short-run AD effect is small; the infrastructure built raises capacity in the long run.

Tips and Tricks

Worked ExampleBoth curves, two time horizons

A New Zealand airline purchases a fleet of new, more fuel-efficient aircraft from an overseas manufacturer. The aircraft are delivered and put into service the following year.

Step 1 — (a) Start with the formula

$AD = C + I + G + (X - M)$

The aircraft are bought from an overseas manufacturer, so the purchase is an import.

Step 2 — Identify the component that changes

$M \text{ (import payments) rises}$

Because $M$ is subtracted in the formula, a rise in $M$ reduces net exports $(X - M)$ and therefore reduces AD.

AD shifts left in the short run.

Step 3 — (b) The long-term effect on aggregate supply

Lower costs mean the airline is willing to supply more at every price level.

AS shifts right, from AS to AS₁.

Step 4 — The effect on economic growth

Reading the new equilibrium where AS₁ cuts AD:

Real GDP rises from Y to Y₁ — this is the economic growth.
The price level falls from PL to PL₁ — cheaper production means lower airfares.

Step 5 — The second-round effect on AD

Lower airfares mean New Zealanders and overseas visitors fly more.

More overseas visitors means higher export receipts ( $X$ ), raising $(X - M)$ .
Cheaper domestic travel raises consumption ( $C$ ) on tourism and hospitality.

So AD shifts right in the long run too — and with both curves shifting right, real GDP rises strongly while the price level changes little.

$\text{Short run: } M \uparrow \Rightarrow AD \leftarrow \qquad \text{Long run: } AS \rightarrow \text{ and } AD \rightarrow \Rightarrow Y \uparrow\uparrow$