Long-run Equilibrium in AP Macroeconomics

Three curves through one point, not just AD meeting SRAS

Long-run equilibrium gets mixed up with short-run equilibrium more than anything else. Short-run equilibrium only needs AD to cross SRAS. That crossing can land left of LRAS, right of it, or right on it.

Long-run equilibrium adds one condition. The AD-SRAS intersection has to sit on the vertical LRAS line at full-employment output (often labeled Yf). Every long-run equilibrium is also a short-run equilibrium, but most short-run equilibria aren't long-run ones.

To tell which state the economy is in, look at where AD and SRAS cross. If they cross left of LRAS, output is below potential, which is a negative (recessionary) output gap. If they cross right of LRAS, output is above potential, which is a positive (inflationary) output gap. If they cross on LRAS, the economy is in long-run equilibrium. This is the core of Topic 3.5, Equilibrium in the AD-AS Model, in Unit 3: National Income and Price Determination.

How flexible wages drag the economy back to LRAS

Topic 3.7, Long-Run Self-Adjustment, asks what happens after a shock when government does nothing. The answer is that flexible wages and prices shift SRAS until the intersection is back on LRAS. AD stays where the shock left it.

In a recessionary gap, unemployment is above the natural rate, so nominal wages fall. Lower production costs shift SRAS right. The price level falls and output rises until real GDP is back at Yf. In an inflationary gap, the labor market is tight, so nominal wages rise. SRAS shifts left, the price level rises further, and output falls back to Yf.

The usual wrong answer has AD shifting back, or LRAS moving to meet the new output level. Self-adjustment runs through SRAS. After a demand shock, output ends up back where it started, but the price level doesn't.

The same reasoning covers a money supply increase starting from long-run equilibrium. If the price level doubles from 100 to 200, the nominal wage has to double too, because the real wage (nominal wage divided by the price level) is unchanged in the long run.

The same resting point drawn on the Phillips curve

Unit 5: Long-Run Consequences of Stabilization Policies redraws long-run equilibrium in Topic 5.2, The Phillips Curve. Here it's the point where the downward-sloping short-run Phillips curve (SRPC) crosses the vertical long-run Phillips curve (LRPC) at the natural rate of unemployment.

The positions flip compared with AD-AS, so watch the direction. A point left of long-run equilibrium on the SRPC means unemployment is below the natural rate, which is an inflationary gap. A point to the right means a recessionary gap. A demand shock moves the economy along the SRPC. Self-adjustment then shifts the SRPC itself, which matches SRAS shifting on the AD-AS graph.

A quick calculation shows up here. With 10 million unemployed out of a 200 million labor force, the unemployment rate is 10 ÷ 200 = 5%. If the natural rate is 4%, the economy is right of long-run equilibrium, and unemployment has to fall 1 percentage point to get back.

Why a spending multiplier can't move long-run output

In the long run, output returns to whatever LRAS says, no matter what happened to AD. A numerical example makes the difference between short-run demand effects and long-run potential output easy to see.

Say the economy is at full employment with real GDP of $1.2 trillion. The government borrows to spend $100 billion more, the multiplier is 4, and crowding out cuts private investment by $60 billion. Those figures tell you about the short-run AD shift. Long-run equilibrium real GDP is still $1.2 trillion, because extra demand at full employment just pushes up the price level once SRAS adjusts.

The only way long-run equilibrium output changes is if LRAS itself shifts. That's where Topic 5.5, Crowding Out, connects. When government borrowing raises interest rates and reduces private investment, the economy may build up less physical capital. Slower capital accumulation can mean slower growth in potential output over time, which shows up as LRAS growing more slowly, not as a gap.

Setting up a graph from "the economy is in long-run equilibrium"

When a stem says the economy starts in long-run equilibrium, it's giving you the starting graph. In multiple choice, you might be asked to describe that condition (output at potential, unemployment at the natural rate) or to name the mechanism that restores it without policy (wage and price adjustment shifting SRAS). Answer choices that bring in government action are the trap.

On Question 1 (Long), and sometimes Question 2 or 3 (Short), a strong answer starts with a correctly labeled AD-AS graph. That means axes labeled price level and real GDP, with AD, SRAS, and a vertical LRAS all crossing at one point, and that output marked as Yf with the price level marked on the vertical axis. From there, show the shock as a shift and label the new short-run equilibrium. If the question asks about the long run with no policy, show SRAS shifting back to LRAS.

One common way to lose points is drawing the starting AD-SRAS intersection slightly off LRAS. If those three curves don't share a point, the graph doesn't show long-run equilibrium.