Give an economy a spending boom and output jumps — for a while. Give it a spending collapse and output slumps — for a while. But zoom out a decade and neither the boom nor the slump defines what the economy can produce; that's set by its workers, capital, and technology. AP Macro encodes this two-speed truth in one picture: a vertical line. Long-run aggregate supply stands at full-employment output no matter what the price level does, and every gap between where the economy is and that line has a name, a diagnosis, and (next lessons) a prescription. This is the graph the long FRQ almost always begins with. Today you make it automatic.
In the long run, all prices — including wages — are fully flexible. Sticky-wage profit effects vanish: if the price level doubles and wages double too, no firm has any reason to change output. So the price level doesn't affect long-run production at all:
LRAS is vertical at full-employment output (Yf) — also called potential output. It's the Lesson 1 PPC and the Lesson 2 trend line in AD-AS clothing, and it corresponds to unemployment at its natural rate (Lesson 3).
LRAS shifts with the same things that shift the PPC: more resources (labor force growth, capital accumulation), better technology/productivity, improved institutions. Notice what's not on the list: the price level, the money supply, consumer confidence. Demand does not build factories. (Economic growth — the sustained rightward march of LRAS — is Lesson 14.)
When short-run equilibrium is not on the LRAS line, the economy has an output gap:
| Gap | Condition | Labor market | Typical cause |
|---|---|---|---|
| Recessionary gap | Y₁ < Yf | Unemployment > natural rate (cyclical UE > 0) | AD fell (or SRAS fell) |
| Inflationary gap | Y₁ > Yf | Unemployment < natural rate | AD boom |
Yes — the economy can temporarily produce beyond Yf: overtime, delayed maintenance, workers pulled in from out of the labor force. It can't stay there, which is exactly what the adjustment mechanism enforces.
The long run arrives through wage adjustment shifting SRAS:
Closing a recessionary gap (no policy): unemployment above natural → slack labor market → wages (eventually) fall → production costs fall → SRAS shifts right → price level falls, output rises back to Yf. New long-run equilibrium: same Yf, lower price level.
Closing an inflationary gap (no policy): unemployment below natural → tight labor market → wages rise → costs rise → SRAS shifts left → price level rises, output falls back to Yf. Same Yf, higher price level.
Two takeaways the exam pays for: 1. In the long run, demand shifts change only the price level. AD right → after adjustment, same Yf, higher PL. This is demand-side neutrality in the long run. 2. Self-correction can be slow — especially downward, because wages resist falling ("sticky downward"). That slowness is the entire case for activist policy: Lesson 8 (fiscal) and Lesson 10 (monetary) are governments deciding not to wait.
Apply It: The economy sits in long-run equilibrium. Business investment collapses. (1) Which curve shifts, which way? (2) Name the gap. (3) Describe the no-policy adjustment. → (1) AD left; (2) recessionary gap; (3) wages eventually fall → SRAS right → back to Yf at a lower price level.
[GRAPH: Long-run equilibrium (the three-curve graph)
X-axis: Real GDP (Y)
Y-axis: Price level (PL)
Curve 1: AD, downward-sloping
Curve 2: SRAS, upward-sloping
Curve 3: LRAS, vertical at Yf
Equilibrium at (Yf, PL₁) — all three curves intersect at one point
Labels required: AD, SRAS, LRAS, PL₁ (dashed to axis), Yf (dashed to axis)]
[GRAPH: Recessionary gap
X-axis: Real GDP (Y)
Y-axis: Price level (PL)
Curves: LRAS vertical at Yf; AD and SRAS crossing at Y₁ LEFT of LRAS
Equilibrium at (Y₁, PL₁) with Y₁ < Yf; horizontal distance Y₁→Yf labeled
"recessionary gap"
Shift (self-correction): wages fall → SRAS shifts right → new equilibrium
at (Yf, PL₂ < PL₁) — output restored, price level lower]
AP labeling requirements: the gap is identified by where AD∩SRAS falls relative to LRAS — left = recessionary, right = inflationary. Dash both coordinates. When asked for "current output and price level," report the AD∩SRAS point, never the LRAS intersection. For an inflationary gap, mirror everything: Y₁ right of Yf; self-correction via SRAS left to (Yf, PL₂ > PL₁).
1. C. Full price-and-wage flexibility severs output from the price level; only real factors (resources, technology) determine long-run production. A: the long run doesn't fix the price level — it frees it. B: demand determines short-run position and long-run prices, not long-run output. D: the long run is when firms can change everything. E: money doesn't pin LRAS.
Fix: Vertical LRAS = "in the long run, output is a real (not nominal) phenomenon."
2. A. Yf is defined by full employment — unemployment at its natural rate. B: the price level is irrelevant to LRAS's position. C: AD∩SRAS is the short-run equilibrium, which may sit anywhere. D: cyclical UE is zero at Yf. E: full employment doesn't require zero inflation.
Fix: LRAS stands where cyclical unemployment is zero — same fact as "output at potential."
3. D. Productivity growth raises what the economy can produce — LRAS right (and SRAS with it). A/E: demand-side events (C via confidence, C via transfers). B: money shifts AD (Lesson 10), never LRAS. C: the price level moves nothing about capacity.
Fix: LRAS shifters = PPC shifters: resources, technology, institutions — nothing nominal.
4. B. AD∩SRAS left of LRAS = recessionary gap = cyclical unemployment = UE above natural. A: that's the right-of-LRAS case. C: long-run equilibrium requires the intersection ON LRAS. D: no runaway inflation is described. E: a positive supply shock would push output up, not below potential.
Fix: Locate AD∩SRAS relative to LRAS: left = recessionary, on = long-run, right = inflationary.
5. E. Beyond potential = inflationary gap = unemployment below the natural rate — overtime and scarce workers. A: positive cyclical UE belongs to recessionary gaps. B: that's exactly at potential. C: LFPR often rises in hot labor markets. D: structural unemployment never disappears.
Fix: Output above Yf ↔ unemployment below NRU — the mirror-image translation.
6. D. AD right along an upward SRAS: both output and price level rise; output beyond Yf = inflationary gap. A: a flat price level would need horizontal SRAS. B/E: wrong directions. C: LRAS constrains the long run — the short run moves.
Fix: Short-run effects come from sliding along SRAS: demand up → PL and Y both up.
7. B. The tight labor market bids wages up → costs rise → SRAS left until AD∩SRAS returns to the LRAS line. A: AD stays put absent policy — self-correction is a supply-side story. C: LRAS doesn't chase demand. D: no such automatic tax mechanism (automatic stabilizers dampen, not restore). E: the price level ends higher, not restored.
Fix: No-policy adjustment = wages move → SRAS moves; AD never "shifts back" on its own.
8. C. Long-run neutrality: output back at Yf, price level permanently higher. A/B: output gains don't survive the long run. D: output isn't lower — it's restored. E: the price level does not return.
Fix: In the long run, AD shifts change the price level only — Yf is untouched.
9. A. Downward wage stickiness (contracts, morale, minimum wages) delays the SRAS-right adjustment — the standard justification for policy intervention. B: the price level can fall; it's wages that resist. C: LRAS isn't moving. D: no such law. E: the NRU is assumed stable in the model.
Fix: Self-correction is asymmetric: wages rise easily (inflationary gaps close fast) but fall grudgingly (recessionary gaps linger).
10. E. Inflationary gap = short-run equilibrium to the right of LRAS. A: that's long-run equilibrium. B: recessionary gap. C: nonsense curves. D: that's a supply shock in progress, not a gap description.
Fix: Gap identification is purely geometric: which side of the vertical line does AD∩SRAS fall on?
11. D. More workers = more productive capacity: LRAS right, and SRAS right with it (more labor at every price level). A: direction wrong and LRAS does move. B: labor force growth is a supply-side event. C: capacity, not just prices, changes. E: self-contradictory.
Fix: Resource growth moves both supply curves right; potential output rises.
12. B. Confidence collapse → AD left → recessionary gap → wages eventually fall → SRAS right → output restored at Yf with a price level below the original PL₁ (the adjustment pushes it below the interim short-run level too). A: mixes gap language with long-run outcome. C: deflation, not inflation, is the long-run result of an AD fall. D: "permanently below" denies self-correction. E: output doesn't overshoot.
Fix: AD left + full adjustment = same Yf, lower PL; AD right + full adjustment = same Yf, higher PL.
13. A. Gaps measure position vs. potential, not changes in potential; LRAS moves only with resources/technology (a hurricane, yes; a demand slump, no). B: gaps are defined by AD∩SRAS relative to a fixed LRAS. C: ordinary recessions idle capacity rather than destroy it. D: reversed definition. E: potential can change — that's growth (or disaster).
Fix: Recessionary gap = operating inside capacity; falling potential = the capacity itself shrank — different diagnoses, different graphs.
The economy of Solden is currently in long-run equilibrium.
(a) Draw a correctly labeled AD–SRAS–LRAS graph for Solden showing equilibrium output Yf and price level PL₁.
(b) The government of a major trading partner enters a deep recession, sharply reducing purchases of Solden's exports. On your graph, show the effect, labeling the new short-run equilibrium output Y₂ and price level PL₂.
(c) Identify the type of output gap Solden now faces, and state whether Solden's unemployment rate is above, below, or equal to its natural rate.
(d) Assuming no policy action, explain how flexible wages eventually restore long-run equilibrium, and state what happens to the price level in the new long-run equilibrium compared with PL₂.
1. C. Full price-and-wage flexibility severs output from the price level; only real factors (resources, technology) determine long-run production. A: the long run doesn't fix the price level — it frees it. B: demand determines short-run position and long-run prices, not long-run output. D: the long run is when firms can change everything. E: money doesn't pin LRAS. Fix: Vertical LRAS = "in the long run, output is a real (not nominal) phenomenon."
2. A. Yf is defined by full employment — unemployment at its natural rate. B: the price level is irrelevant to LRAS's position. C: AD∩SRAS is the short-run equilibrium, which may sit anywhere. D: cyclical UE is zero at Yf. E: full employment doesn't require zero inflation. Fix: LRAS stands where cyclical unemployment is zero — same fact as "output at potential."
3. D. Productivity growth raises what the economy can produce — LRAS right (and SRAS with it). A/E: demand-side events (C via confidence, C via transfers). B: money shifts AD (Lesson 10), never LRAS. C: the price level moves nothing about capacity. Fix: LRAS shifters = PPC shifters: resources, technology, institutions — nothing nominal.
4. B. AD∩SRAS left of LRAS = recessionary gap = cyclical unemployment = UE above natural. A: that's the right-of-LRAS case. C: long-run equilibrium requires the intersection ON LRAS. D: no runaway inflation is described. E: a positive supply shock would push output up, not below potential. Fix: Locate AD∩SRAS relative to LRAS: left = recessionary, on = long-run, right = inflationary.
5. E. Beyond potential = inflationary gap = unemployment below the natural rate — overtime and scarce workers. A: positive cyclical UE belongs to recessionary gaps. B: that's exactly at potential. C: LFPR often rises in hot labor markets. D: structural unemployment never disappears. Fix: Output above Yf ↔ unemployment below NRU — the mirror-image translation.
6. D. AD right along an upward SRAS: both output and price level rise; output beyond Yf = inflationary gap. A: a flat price level would need horizontal SRAS. B/E: wrong directions. C: LRAS constrains the long run — the short run moves. Fix: Short-run effects come from sliding along SRAS: demand up → PL and Y both up.
7. B. The tight labor market bids wages up → costs rise → SRAS left until AD∩SRAS returns to the LRAS line. A: AD stays put absent policy — self-correction is a supply-side story. C: LRAS doesn't chase demand. D: no such automatic tax mechanism (automatic stabilizers dampen, not restore). E: the price level ends higher, not restored. Fix: No-policy adjustment = wages move → SRAS moves; AD never "shifts back" on its own.
8. C. Long-run neutrality: output back at Yf, price level permanently higher. A/B: output gains don't survive the long run. D: output isn't lower — it's restored. E: the price level does not return. Fix: In the long run, AD shifts change the price level only — Yf is untouched.
9. A. Downward wage stickiness (contracts, morale, minimum wages) delays the SRAS-right adjustment — the standard justification for policy intervention. B: the price level can fall; it's wages that resist. C: LRAS isn't moving. D: no such law. E: the NRU is assumed stable in the model. Fix: Self-correction is asymmetric: wages rise easily (inflationary gaps close fast) but fall grudgingly (recessionary gaps linger).
10. E. Inflationary gap = short-run equilibrium to the right of LRAS. A: that's long-run equilibrium. B: recessionary gap. C: nonsense curves. D: that's a supply shock in progress, not a gap description. Fix: Gap identification is purely geometric: which side of the vertical line does AD∩SRAS fall on?
11. D. More workers = more productive capacity: LRAS right, and SRAS right with it (more labor at every price level). A: direction wrong and LRAS does move. B: labor force growth is a supply-side event. C: capacity, not just prices, changes. E: self-contradictory. Fix: Resource growth moves both supply curves right; potential output rises.
12. B. Confidence collapse → AD left → recessionary gap → wages eventually fall → SRAS right → output restored at Yf with a price level below the original PL₁ (the adjustment pushes it below the interim short-run level too). A: mixes gap language with long-run outcome. C: deflation, not inflation, is the long-run result of an AD fall. D: "permanently below" denies self-correction. E: output doesn't overshoot. Fix: AD left + full adjustment = same Yf, lower PL; AD right + full adjustment = same Yf, higher PL.
13. A. Gaps measure position vs. potential, not changes in potential; LRAS moves only with resources/technology (a hurricane, yes; a demand slump, no). B: gaps are defined by AD∩SRAS relative to a fixed LRAS. C: ordinary recessions idle capacity rather than destroy it. D: reversed definition. E: potential can change — that's growth (or disaster). Fix: Recessionary gap = operating inside capacity; falling potential = the capacity itself shrank — different diagnoses, different graphs.
Exam tip: The three-curve graph is the FRQ's opening move year after year. Build it in ritual order: axes → LRAS at Yf → AD and SRAS crossing deliberately left of, on, or right of LRAS depending on the prompt → dash both coordinates. Then every follow-up ("what gap?", "what happens to unemployment?", "show the long-run adjustment") reads directly off your drawing. Next lesson: the government stops waiting for self-correction — fiscal policy.