Case Study 2 — COVID as a Simultaneous AD-AS Shock

COVID 2020 was the hardest kind of shock for the AS-AD model to handle: AD shifted left AND SRAS shifted left at the same time. This case study walks through the model's predictions and compares them to what actually happened.

The simultaneous shock

AD shift left: consumers stayed home, businesses closed, fear reduced spending → AD left. SRAS shift left: factories closed, supply chains broke, workers couldn't work → SRAS left.

Model predictions

Both shifts reduce GDP (unambiguous: both push output down). The effect on the price level is ambiguous: AD-left pushes prices down, SRAS-left pushes prices up. The net depends on which shift is larger.

What actually happened

Q2 2020: GDP collapsed (−31% annualized). Inflation was muted — the demand and supply effects roughly canceled on prices. Headline CPI was near zero or slightly negative.

2021: demand recovered (AD shifted back right, boosted by $5T fiscal stimulus). Supply recovered more slowly (supply chains still disrupted, labor force participation still depressed). Result: AD was right of SRAS → inflationary gap → prices surged. Inflation hit 9.1% by June 2022.

2022–2024: the Fed tightened (AD shifted back left via rate hikes). Supply continued to heal (SRAS shifted right). Result: inflation fell toward 2% without a recession.

The lesson

The AS-AD model correctly predicted the direction of GDP (down in 2020) and the inflation aftermath (too much AD into too little SRAS = inflation). It struggled with the timing and magnitude because simultaneous shocks are hard to model in real time. The COVID episode is the most dramatic AS-AD case study in modern history.

Discussion questions

  1. Show the COVID shock on an AS-AD diagram: initial position → Q2 2020 (both shifts left) → 2021 (AD recovers, SRAS still left) → 2023 (both returning to normal).
  2. Why was the price-level effect ambiguous in Q2 2020 but inflationary in 2021?
  3. The Fed's 2022–23 tightening was an AD-left shift. Show it on the diagram. Why didn't it cause a recession?