Tracing a Policy Action Across the Graphs

A single policy move never shows its whole story on one graph. The money market shows what happens to the interest rate first. Investment demand shows how firms react to that rate. AD-AS shows what the change in spending does to output and the price level. Each graph answers a different question, and the output of one graph is the input to the next, so skipping a step breaks the chain.

Take an open market sale: the Fed sells bonds, the money supply curve shifts left, and the equilibrium interest rate rises. Move to the investment graph: a higher interest rate makes borrowing more expensive, so planned investment falls. That drop in investment is a fall in a component of spending, so AD shifts left. On the AD-AS graph, the leftward shift lowers both real output and the price level, assuming SRAS is upward sloping. A fiscal action like a tax increase skips the money market entirely and starts straight at AD, through its effect on disposable income and consumption, but still finishes on the same AD-AS graph.

This matters because the size of the final effect on output versus price depends on where the economy sits on SRAS. Near full employment, SRAS is steep, so most of an AD shift shows up as a price change rather than an output change; far from full employment, SRAS is flatter, and more of the shift becomes real output. That same logic is what you will use next to judge how a policy's short-run gain in output trades off against inflation, and whether the long-run effect looks different once SRAS adjusts.