Again we take example of an economy with a stable equilibrium with actual GDP being equal to potential GDP. Now, suppose the entrepreneurs decide to reduce the investment expenditure. It will causes a downward shift in the aggregate demand curve, also called concretionary shock. The new equilibrium will now be attained at the lower level of GDP and price level. It sets in motion the econtractionary forces resulting into decreasing demand forces all inputs, including the demand for labour. Input costs fall and the aggregate supply curve shifts rightwards setting a new and original level of output which is equal to potential output, but it is obtained at a lower price level as shown.


In both the parts (i) and  (ii) E₀ is the initial equilibrium, where AD₀ curve intersects SRAS₀ curve. The actual level of output (GDP) equals the potential level (Y*) at the price level P₀. Now, a fall in the investment spending causes a demand shock and the AD₀ curve in part (i) shifts downwards to AD₁. This causes a fall in both GDP and the price level. At the new equilibrium E₁ in both the parts (i) and (ii), the new and lower level of GDP is Y₁ and the price level also falls to P₁. But, this is not the final equilibrium.

Aggregate demand shocks sets in motion the recessionary forces. Since actual GDP (Y₁) is less than potential GDP (Y*) results into a fall in input costs, including the cost of labour, shifting the SRAS₀ curve downwards to SRAS₁, as shown in part (ii), New equilibrium if E₂, where AD₁ intersects the new aggregate supply curve SRAS₁. At point E₂, recessionary gap is eliminated, as shown by arrow in part (ii), and actual GDP again becomes equal to potential GDP, but at a lower price level P₂.

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