Long-run equilibrium

LRAS (long-run aggregate supply) is at a level of output that corresponds to equilibrium in labor market

The preceding economy

• Starts from a full employment equilibrium.(equilibrium in the labor market)

• This means that AD and AS intersect LRAS and that the economy is operating at its potential level of RGDP (Real GDP).

• Imagine now that the something happens to decrease AD.

The short-run effects will be ...

As the equilibrium price level and output decrease

This creates excess supply in the labor market

The excess supply (high unemployment and high real wages) forces wages down

and as wages decrease ...

AS shifts back to the right

In the long-run

(Where labor markets have time to fully adjust to changes that have

taken place in the goods market) the economy returns to its potential level

of RGDP.

Now take the opposite case:

• Start again from a full employment equilibrium.

• This means that the economy is operating at its potential level of RGDP.

• Imagine now that the something happens that causes AD to increase.

The short-run effects will be ...

As the equilibrium price level and output increase

This creates excess demand in the labor market

The excess demand (low unemployment and low real wages) forces wages up and as

wages increase ...

AS shifts back to the left

In the long-run

(Where labor markets have time to fully adjust to changes that have

taken place in the goods market) the economy returns to its potential level

of RGDP.