Short on time? This page is the recap. For explanations, graphs and worked examples, use the full study guide.
Recap
- Short-run equilibrium: aggregate quantity demanded = aggregate quantity supplied, where AD crosses SRAS. It gives the equilibrium price level (PL₁) and real output (Y₁).
- Above the equilibrium price level there is a surplus: inventories rise unexpectedly, so the price level and output fall. Below it there is a shortage: inventories fall, so the price level and output rise.
- Long-run equilibrium: AD and SRAS cross on LRAS, so Y₁ = Yf and unemployment equals the natural rate.
- Short-run equilibrium can be below, at or above Yf.
- Output gap = actual real GDP − Yf. Negative = recessionary. Positive = inflationary.
Key relationships
| Short-run equilibrium | Output gap | Unemployment vs natural rate | Cyclical unemployment |
|---|---|---|---|
| Left of LRAS | Negative (recessionary) | Above | Positive |
| On LRAS | Zero | Equal | Zero |
| Right of LRAS | Positive (inflationary) | Below | Negative |
| Quantity | Formula |
|---|---|
| Output gap | actual real GDP − Yf |
| Gap as % of Yf | (actual − Yf) ÷ Yf × 100 |
| Surplus at a price level | real GDP supplied − real GDP demanded |
Assumptions
- Nominal wages and some other input prices are sticky in the short run, so SRAS slopes upward.
- Yf and the natural rate are fixed unless the question says otherwise.
- Shifts of AD and SRAS are Topic 3.6; how a gap closes in the long run is Topic 3.7.
Mistakes to avoid
- Saying the economy is at full employment just because AD = SRAS.
- Finding short-run equilibrium where SRAS meets LRAS.
- Getting the sign of the gap wrong: below Yf is negative.
- Linking a recessionary gap with unemployment below the natural rate.
- Shifting a curve to remove a surplus. The economy moves along AD and SRAS.
- Drawing long-run equilibrium without all three curves crossing at one point.
- Labelling axes “price” and “quantity” instead of price level and real GDP.
Quick self-check
VD is the valda, the currency of the fictional country Valdoria used in the study guide.
- At a price level of 115, real GDP demanded is VD 440 billion and real GDP supplied is VD 470 billion. Surplus or shortage? Which way does the price level move? (Surplus of VD 30 billion; it falls)
- Equilibrium real GDP is VD 470 billion and Yf is VD 500 billion. Size and type of gap? (−VD 30 billion, −6%; negative, recessionary)
- Unemployment is 3.8% and the natural rate is 4.5%. Where is short-run equilibrium? (Right of LRAS; positive, inflationary gap)
Next: practice questions.