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This diagram shows how contractionary fiscal or monetary policy shifts the aggregate demand (AD) curve leftward, reducing inflationary pressure but also decreasing real GDP.
AD1: Initial aggregate demand before contractionary policy.
AD2: Aggregate demand after contractionary fiscal or monetary policy.
SRAS: Short-run aggregate supply, unchanged in this diagram.
LRAS: Long-run aggregate supply at full employment output.
PL1: Initial price level before the policy intervention.
PL2: Lower price level after AD decreases.
Y2: New equilibrium output after demand contraction.
Ye: Full employment level of output.
Contractionary policy is used to reduce inflation by decreasing aggregate demand (AD).
Initially, the economy is in equilibrium at AD1, SRAS, and price level PL1, at the full employment output (Ye).
A shift from AD1 to AD2 reflects the effects of contractionary fiscal policy (e.g., reduced government spending or increased taxes) or contractionary monetary policy (e.g., higher interest rates, reduced money supply).
This leads to a lower equilibrium output (Y2) and a lower price level (PL2), reducing inflationary pressure but potentially increasing unemployment.
The diagram demonstrates how macroeconomic policy can stabilize the economy when aggregate demand is too high.
Explore other diagrams from the same unit to deepen your understanding
A diagram illustrating the fluctuations in real GDP over time, including periods of boom, recession, peak, and trough, relative to the long-term trend of economic growth.
This diagram shows the intersection of the aggregate demand (AD) and short-run aggregate supply (AS) curves to determine the equilibrium price level and real GDP.
A diagram showing the Classical model of aggregate demand (AD), short-run aggregate supply (SRAS), and long-run aggregate supply (LRAS), used to explain long-run macroeconomic equilibrium.
A Keynesian aggregate demand and long-run aggregate supply (AD–LRAS) diagram showing how real GDP and the price level interact across different phases of the economy, including spare capacity and full employment.
A diagram showing an output (deflationary) gap, where the economy is producing below its full employment level of output (Ye).
A macroeconomic PPC diagram illustrating the trade-off between producing consumer goods and capital goods, highlighting opportunity cost and future growth implications.
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