One diagram explains why prices and output move together or apart. Learn to read macroeconomic equilibrium and the output gap, and you can analyse almost any macro question.
Why can prices rise even when output is falling, and why does demand-side thinking not explain it?
Aggregate demand (AD) is total planned spending at each price level. Aggregate supply (AS) is total output firms will produce. Where they meet is macroeconomic equilibrium. Shifts in either curve change the price level and real output. The output gap shows how far actual output is from potential.
Aggregate demand (AD) is the total planned spending on a country's goods and services at each price level, in a given period. It has four components.
The AD curve slopes downwards. A higher price level cuts the real value of savings (the wealth effect). It tends to raise interest rates, which cuts borrowing and spending. It also makes UK goods dearer abroad, so net exports fall.
Short-run aggregate supply (SRAS) is the total output firms will produce at each price level when some costs, such as wages, are fixed. It slopes upwards because higher prices with fixed input costs make extra output profitable.
Long-run aggregate supply (LRAS) is the economy's potential output when all resources are used normally. Two views exist. The classical view draws LRAS as a vertical line, because output depends on the quantity and quality of resources, not on prices. The Keynesian view draws it with a flat section, because a deep recession leaves resources idle, so output can rise without pushing up prices.
Macroeconomic equilibrium is where AD meets SRAS. It sets the price level and real output (real GDP, output adjusted for price changes). It may not be at potential output.
Illustrative figures: actual GDP is £2,450bn and potential GDP is £2,500bn. The gap is −50 ÷ 2,500 × 100 = −2%. Firms and workers are underused, so inflation pressure is weak and unemployment is likely to be above its normal level.
A change in the price level moves you along a curve. Any other change shifts the curve. Keep these two ideas apart.
An AD shift to the right, with SRAS upward-sloping, raises both prices and output. This is demand-pull inflation. Near full capacity, most of the effect falls on prices, because SRAS is steep there. In a deep recession, most falls on output.
A leftward SRAS shift is different. It raises the price level and lowers real output at the same time. This is cost-push inflation, and the diagram shows why demand-side thinking cannot explain it. Output falls and prices rise, so the economy moves away from the demand-pull pattern.
Read Figure 1 in steps. Start at E1 on LRAS, where output is at potential. A rise in energy costs shifts SRAS left. The new equilibrium E2 has a higher price level (P2) and lower output (Y2). Output now sits below potential, so a negative output gap has opened.
Examiners reward you for saying what the outcome depends on. Four factors do most of the work.
The 2022 energy shock shows the cost-push case. UK inflation peaked at 11.1% in October 2022.[1] The Energy Price Guarantee held down the effect on prices, but it did not remove the cost shock.[2]
The 2026 data show the output gap in use. The Bank of England and the Institute for Fiscal Studies (IFS), a UK economics research body, both put the UK slightly below potential.[3][4] That matters for policy because spare capacity suggests demand can rise without strong inflation pressure.
Judge the diagram too. It is a snapshot. It does not show the path of adjustment, expectations, or the fact that AD and AS affect each other. Investment in a boom can raise capacity later, so a demand shift can move LRAS.
Label every curve and every equilibrium. Mark potential output on the horizontal axis. An unlabelled diagram loses AO1 marks even when the shape is right.
The economics is the same on every board; the question format is what changes. Most questions on this topic take one of six shapes. Open each to see how the topic appears in it and what earns the marks. All questions here are original Curriculum Circle practice questions, not board questions.
On this topicCommon. Expect questions on which factor shifts AD or SRAS, the sign of the output gap, or what a diagram shows.
What earns the marksAO1 for definitions and AO2 for reading a shift correctly.
CC practice questionWhich one of the following would shift SRAS to the left? A a fall in the exchange rate that raises import costs; B a rise in consumer confidence; C a cut in income tax; D a rise in government spending. (1 mark)
On this topicRegular. You may calculate the output gap, or the change in real GDP, from data.
What earns the marksAO1 for the formula and AO2 for applying it and stating what the sign means.
CC practice questionIllustrative figures: actual GDP is £1,960bn and potential GDP is £2,000bn. Calculate the output gap as a percentage of potential GDP and state what it suggests about inflation pressure. (3 marks)
On this topicCommon. Explain why one curve shifts, or why the AD curve slopes downwards.
What earns the marksAO1 for knowledge, AO2 for the context and AO3 for a short chain of reasoning.
CC practice questionExplain how a rise in business taxes could affect the price level and real output. (6 marks)
On this topicVery common. This is the classic draw-and-explain task with a shift and a before-and-after comparison.
What earns the marksAO2 for using the data or context and AO3 for a developed chain with an accurate diagram.
CC practice questionUsing an AD/AS diagram, analyse how a sharp rise in global energy prices could affect UK inflation and real output. (9 marks)
On this topicCommon. Usually a policy or data extract about inflation, growth or the output gap.
What earns the marksAO1 to AO4, with most marks on AO3 analysis and AO4 judgement, such as how big the gap is and how long the shock lasts.
CC practice questionEvaluate the view that a negative output gap means the government should increase spending. (12 marks)
On this topicRegular, often linked to growth, inflation or policy. AD/AS is the engine for the analysis in both sides of the argument.
What earns the marksAO1 to AO4 across the answer, with AO4 deciding the top band through a supported judgement.
CC practice questionEvaluate whether supply-side shocks are more damaging to an economy than falls in aggregate demand. (25 marks)
| Weight | What it is | What it means on aggregate demand and aggregate supply analysis | |
|---|---|---|---|
| AO1 | 20–23% | Knowledge and understanding of terms, concepts, theories and models | Know what AD, SRAS and LRAS are, what shifts each, and the output gap formula. Draw the diagram with correct labels. |
| AO2 | 26–29% | Application to economic contexts | Apply the model to the context given: which curve moves, in which direction, and why this economy and this period. |
| AO3 | 26–29% | Analysis of issues and their impact on economic agents | Build chains such as higher energy costs, SRAS left, higher prices, lower output, a negative gap and rising unemployment. |
| AO4 | 22–25% | Evaluation, using evidence to reach a judgement | Judge by size, time and spare capacity: how large the shock is, whether it is temporary, and how reliable the gap estimate is. |
Weightings are approximate and taken from the AQA A-level Economics 7136 specification [0]. Edexcel and IAL weight the objectives differently, but they test the same four skills.
Evaluate whether a rise in global energy prices is more damaging to the UK economy than a fall in consumer spending. (25 marks)
A rise in global energy prices raises firms' input costs, so SRAS shifts left. At the new equilibrium the price level is higher and real output is lower. Output falls below potential, so a negative output gap opens and unemployment may rise.
A fall in consumer spending lowers C, so AD shifts left. With upward-sloping SRAS, the price level and real output both fall. The output gap is again negative, but inflation falls rather than rises.
The difference matters because the energy shock pushes inflation and output in opposite directions. Policymakers then face a trade-off: raising interest rates fights inflation but lowers output further.
The damage depends on size and duration. A temporary energy spike may fade as costs adjust and SRAS shifts back. A large fall in spending in a weak economy can last longer, because spare capacity pushes down wages and prices slowly.
It also depends on the starting point. If the economy has a negative gap already, as the Bank of England and the IFS judged in mid-2026, a further AD fall adds to unemployment.[3][4] If inflation is already high, the energy shock hits real incomes harder, as in 2022 when UK inflation peaked at 11.1%.[1]
On balance, the energy shock is usually more damaging in the short run, because it combines higher prices with lower output and limits the policy response. The spending fall can be more damaging when it is deep and persistent. My judgement is that the answer turns on whether the shock is temporary, so I would argue the supply shock is worse only while it lasts.
UK CPI inflation peaked at 11.1% in October 2022, a 41-year high.[1] The Office for National Statistics (ONS), the UK statistics body, estimated it would have been around 13.8% without the Energy Price Guarantee.[2] The Guarantee kept a typical household's annual energy bill at £2,500 from October 2022 to June 2023.[5]
In July 2026 the Bank of England said most model-based estimates of the output gap pointed to slack of around 1% of potential GDP.[3] The IFS judged that real GDP in the second quarter of 2026 was around 1 to 1.5% below potential.[4]
UK CPI inflation fell to 1.7% in September 2024, then rose to 3.5% in September 2026.[1] In July 2026 the Bank of England still reported modest spare capacity, partly reflecting weak demand.[3] A demand-only story struggles to explain rising prices alongside spare capacity, so cost factors need analysing too.
Everything above is the topic page. The pieces below take it further. Each one trains a particular assessment objective rather than covering the topic again, and they are added over the year.
Figures and facts were checked against these sources on 2 November 2026. Worked numbers labelled "Illustrative figures" are invented for teaching.
The CC Economics revision platform drills AD/AS diagrams and output-gap calculations, and the Inner Academy covers the topic in recorded lessons.
See the Economics platformThe Inner Academy