A Housing Boom and the Wealth Effect
Rising home values make households wealthier, so consumer spending rises and AD shifts right, which is a shift of AD rather than a movement along it.
A Housing Boom and the Wealth Effect
AD-AS ModelRising home values make households wealthier, so consumer spending rises and AD shifts right, which is a shift of AD rather than a movement along it.
Equilibrium at Real GDP (Y) 80, Price Level (PL) 60
Long-run equilibrium
The economy starts in long-run equilibrium, where AD crosses SRAS exactly on LRAS. Real GDP equals the full-employment level of output and the price level is stable. Everything that follows is measured against this starting point.
Now try it yourself: shift the curves in a graded FRQ drill, or open this graph in the free sandbox.
Students predict what happens before the graph moves. No accounts, nothing graded.
A Housing Boom and the Wealth Effect, step by step
- 1
Long-run equilibrium
The economy starts in long-run equilibrium, where AD crosses SRAS exactly on LRAS. Real GDP equals the full-employment level of output and the price level is stable. Everything that follows is measured against this starting point.
- 2
Wealthier households spend more
Homeowners are now sitting on far more wealth than before, even though their paychecks have not changed. Consumer wealth is a determinant of aggregate demand, so households spend more on cars, furniture and travel at every price level, and AD shifts right. No production cost has changed, so SRAS stays where it is.
- 3
Output climbs above potential
The new AD meets the unchanged SRAS to the right of LRAS, so real GDP has run past the full-employment level and the price level has climbed with it. That is an inflationary gap. Firms are filling the extra orders with overtime and added shifts, so unemployment now sits below its natural rate.
- 4
A shift, not a movement
Watch which curve moved and why. A lower price level also raises the real value of what households hold, and that is the wealth effect built into the downward slope of AD, a movement along the curve. Here the price level did not move first. House prices did, so wealth changed at every price level and the whole AD curve shifted right.
Where it ends up
Greater household wealth shifts the whole AD curve right, so the price level and real GDP both rise. Do not confuse this with the wealth effect that makes AD slope downward, which is a movement along a fixed AD curve.
Now draw it yourself
Same graph, graded on whether you move the right curve and leave the rest alone.
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