Higher costs can raise prices while reducing output.
An adverse short-run supply shock raises production costs or restricts available inputs. With AD unchanged, an upward/leftward AS shift raises the equilibrium price level and reduces real output. A favourable supply shift has the opposite effects under the usual curves. If AD also changes, separate the effects: some outcomes may reinforce one another while others oppose. Do not force a definite answer where the relative sizes of shifts are unknown. Evidence that output fell alone cannot identify whether the original cause was demand, supply or both.
- Adverse supply shock
- AS up/left with unchanged AD reduces output and raises the price level.
- Favourable supply shock
- AS down/right with unchanged AD raises output and lowers the price level.
- Simultaneous shifts
- Separate each effect and identify whether effects reinforce or oppose.
Apply the idea
Relative effects
Where two shifts oppose, their relative strength and curve shapes determine the final direction; arrow counts do not settle it.
Price level and inflation
An adverse shock can generate a rise in the price level during adjustment. Persistent inflation needs a time path or repeated pressures, not just two equilibria.
| AD change | AS change | Real output | General price level |
|---|---|---|---|
| Right | Down/right | Rises | Uncertain |
| Left | Up/left | Falls | Uncertain |
| Right | Up/left | Uncertain | Rises |
| Left | Down/right | Uncertain | Falls |
Worked example: Higher fuel costs and stronger demand together
Begin with AD: P = 200 - Y and AS: P = 50 + 0.5Y. A cost increase changes AS to P = 65 + 0.5Y. Then consider an additional demand increase to P = 230 - Y.
- With the cost increase alone, 200 - Y = 65 + 0.5Y gives 135 = 1.5Y, so Y = 90 and P = 110: lower output and higher prices.
- With both shifts, 230 - Y = 65 + 0.5Y gives 165 = 1.5Y, so Y = 110 and P = 120. In this particular model, the demand expansion more than offsets the output loss.
- More generally, AD right and AS up/left both raise the price level, but their output effects oppose. The net output result depends on their relative strength.
- Report the numerical result only when the schedules or comparable magnitudes are given; otherwise state which outcome is uncertain.
Watch out for this
Whenever costs rise and AD rises, output must fall.
The cost shock lowers output while higher AD raises it. Without their relative effects, the net output change is uncertain.
Check your understanding
AD falls while AS shifts up/left. Under the usual curves, which outcome is definite?
- The price level must rise.
- Real output falls.
- Real output must rise.