In micro, a supply curve is drawn along costs. In macro, short-run supply hangs on the prices people expected.
When prices turn out higher than expected, 🏪 shops happily produce more. Once expectations catch up, output returns to its normal place. A demand shock ends up raising only prices over time. A supply shock, like pricier 🛢️ oil, cuts output and raises prices together. As the shock fades, the economy slowly finds its way back.
For example, a snack bar 🧑 owner expects plates to sell at 3,000 won and stocks up for a normal week. A festival suddenly floods the shop, so the owner cooks late into the night. Next year the owner plans for higher prices from the start, and output is back to normal. After the busy spell, only the higher prices remain.
The government spends more and aggregate demand shifts right by 20.
What are output and the price level in the first year, and what is left after 10 years?
Demand shock 20, year 0 — expected prices are still stuck at 10.Show proof
In the short run the expected price Pe=10 pins the short-run supply curve, so equilibrium is Y=113.3, P=11.33. Output sails past its natural level of 100 — factories run overtime and shops hire.
Year by year, people build the higher prices into their expectations.
As Pe catches up, the short-run supply curve climbs and output hands back a chunk of the gap each year.
Push the time slider to the end and watch.
In the end output returns to Y=100 and the price level settles at P=14. All a demand shock leaves behind, given time, is higher prices — not higher output.
Oil prices jump and production costs rise — a supply shock that lifts the short-run supply curve by 2.
How do output and prices move in the first year?
Supply shock of size 20 (the curve lifts by +2), year 0.Show proof
The new equilibrium is Y=93.3, P=11.33.
Output drops below its natural level while prices rise — both go the wrong way.
That is stagflation.
It looks like a supply drop in one micro market, but here the whole economy's prices and output shake together. That is the central bank's dilemma: cut rates and prices jump further; raise them and output falls further.
This shock is temporary and halves every year.
Expected prices rise for a while, then settle back, and in the end Y=100, P=10 is restored.