Use the AD-AS model to explain how economic fluctuations are caused by demand/supply shocks
An economic recession happens as a result of negative shocks of demand or supply causing a fall of the RGDP equilibrium level below the GDP potential. A decrease in the confidence of consumers shifts AD equilibrium to the left taking a lower quality of output and low level of the price than the initial equilibrium. Due to this, the real GDP output gets below the potential GDP output leading to increased tax or spending by the government and eventually, decreased spending by consumers. This drastically fluctuates the economy.
Explaining the short-run effect of a demand/supply shock and the long-run effect of the shock when the economy self corrects
A sudden change greatly affects the price equilibrium of both goods and services and the general economic price. A wide economic supply shock that is negative shifts the curve of supply to the left while it decreases output and increases the level of prices. A change in demand or supply shocks in the self-adjusted economy changes AD or AS and then unemployment and output changes only in the short-run. The output gap begins to exist in AD or AS since price adjustment is not to the fullest. An increase in confidence leads to increased spending causing positive AD or AS shock.
Consumer spending causes an increase in AD or AS curve, thus increasing output and decreasing the rate of unemployment. An increase in either AD or AS increases both the level of price and real GDP ((Khan Academy, no page). Inflation reduces wages and workers respond by demanding wage rise, driving labor cost. SRAS, therefore, decrease due to the rising labor cost. The level of price increases while decreasing the output creating an output of full unemployment. The natural rate of unemployment then goes down, and pressure on both prices and wages increase. GDP returns to the employment output level that is full, equating unemployment rate to its natural rate.