Short on time? This page is the recap. For explanations, graphs and worked examples, use the full study guide.
Recap
- Short run: some input prices, especially nominal wages, are fixed. Long run: all wages and prices have adjusted fully. Neither is a fixed number of years.
- The LRAS curve is vertical at full-employment output (Yf), also called potential output.
- Why vertical: in the long run, input prices rise or fall with the price level, so real profit per unit does not change. Output depends only on resources and technology.
- At Yf, unemployment equals the natural rate; cyclical unemployment is zero.
- No long-run trade-off between inflation and unemployment: any price level gives Yf and the natural rate in the long run.
- LRAS and the PPC both show maximum sustainable capacity.
Key relationships
| Situation | PPC | AD–AS model |
|---|---|---|
| Full employment | On the curve | Real GDP = Yf, on LRAS |
| Unemployed resources | Inside the curve | Real GDP < Yf, left of LRAS |
| Resources over-used for a time | Beyond the curve: not sustainable | Real GDP > Yf, right of LRAS |
| More resources or better technology | Shifts out | LRAS shifts right (Topic 3.7) |
| Curve | Slope | Reason |
|---|---|---|
| SRAS | Upward | Sticky wages and prices |
| LRAS | Vertical | Fully flexible wages and prices |
Assumptions
- In the long run every input price changes in proportion to the price level.
- Resources and technology are fixed unless the question says otherwise.
- How the economy returns to Yf after a shock is Topic 3.7.
Mistakes to avoid
- Saying LRAS is vertical because wages are sticky (that explains SRAS).
- Equating full employment with zero unemployment.
- Saying output cannot exceed Yf. It can, but not sustainably.
- Shifting LRAS left when the economy is merely inside its PPC.
- Defining the long run as a number of years.
- Claiming a higher price level raises long-run real output. It raises nominal values only; real output stays at Yf.
- Shifting LRAS for a temporary rise in input prices. That shifts SRAS only; LRAS moves when capacity changes.
Quick self-check
VD is the valda, the currency of the fictional country Valdoria used in the study guide.
- Labour force 25.0 million, natural rate 5.0%, unemployment 6.0%. How many people are cyclically unemployed? (0.25 million)
- A firm’s price rises 10% from VD 50; costs of VD 40 also rise 10%. Real profit per unit? (VD 10, unchanged)
- Unemployment is below the natural rate. Left or right of LRAS? (Right)
Next: practice questions.