AD-AS Model: Equilibrium in the Short Run and Long Run - Online Tutor, Practice Problems & Exam Prep

In the AD-AS model, long-run equilibrium occurs where aggregate demand, short-run aggregate supply, and long-run aggregate supply intersect, determining the equilibrium price level and GDP. In contrast, short-run equilibrium may differ due to shifts in aggregate demand or supply, leading to a new intersection point. Understanding these dynamics is crucial for analyzing economic fluctuations, as shifts can result in varying price levels and GDP, impacting overall economic stability and growth.

Equilibrium in the Long Run

Alright. So now let's put together everything we've learned about aggregate demand and aggregate supply to find equilibrium in the long run and the short run. So this is what the ADAS model is coming to. We're looking for the equilibrium amount of GDP and price level in the economy. Okay? So the long run equilibrium is going to be where the aggregate demand, short run aggregate supply, and long run aggregate supply all intersect together. Okay? So remember, in the market supply curve, we were drawing some shape like this. Right? We had our graph and we were looking for a shape that looked like this, and this middle point was our equilibrium. Right? Right in the middle of the x of demand and supply. Well, when we're doing the long run equilibrium with aggregate demand aggregate supply, we've got three curves we're dealing with here. We've got our aggregate demand, our short run aggregate supply, and long run aggregate supply. So our graph is going to look more like this. We're going to have the x from before. This is our aggregate demand, aggregate supply, and then our long run aggregate supply. So we're going to have this star shape where all three of them mix right there in the middle, well, that is going to be our long run equilibrium. Remember, we've got our price level on this side of the graph, the y-axis, and we've got our real GDP, the amount of production in the economy there on our x-axis. So as we saw, we had our aggregate demand curve was downward sloping like this, and that's aggregate demand. And then we had short-run aggregate supply going up like this. And then we had our long run aggregate supply. So when we're in long run equilibrium, all three of the curves are going to pass through the same point just like that, and we're going to have our equilibrium right here in the middle. And this will be our equilibrium price level right here, and this will be the equilibrium amount of GDP right here. Okay? So the long run equilibrium is where all three of the curves cross each other. Now, let's talk about the short run equilibrium in the.

Equilibrium in the Short Run

Well, in the short run, it's possible that we're not in long run equilibrium. We might be in the long run equilibrium, but we might not. So what we might see is we might have had some sort of situation like this where we had our aggregate demand and I'm going to say aggregate demand 1. We're going to have our aggregate supply, short run aggregate supply. And then we'll have our long run aggregate supply going straight up. Let's say in the short run, something has caused the aggregate demand to shift. Right? So, the aggregate demand may have shifted to the left. Let's say aggregate demand shifted to the left. In the short run, we might not be in the long run equilibrium. Well, our short run equilibrium is where our aggregate demand meets with our short run aggregate supply. Right? When we're thinking about the short run, we got to think about the short run equilibrium with aggregate demand. Remember, there's no short run and long run aggregate demand. Aggregate demand and our short run aggregate supply. So, that would be this point right here would be our short run equilibrium. Right here, I'm going to write it in. Short run equilibrium. Okay? Right at that point where the short run aggregate supply is touching the shifted aggregate demand curve. Right? So, that could have been any of those curves could have shifted. Our short run aggregate supply, our aggregate demand, anything could have shifted leading to some other short run equilibrium other than our long run equilibrium. Right? So this would be our short run equilibrium right here as far as the price level goes would be right here. Price level and I'll say in the short run and GDP in the short run. Right? So it would have shifted and we would have had this different short run equilibrium. Alright? So there's a lot of different lines going on there. So what I like to do is I like to keep our original situation in one color just like this and draw our new curves in a different color like I did with the red aggregate demand curve. It makes it a lot easier to see which curve was there originally and which is the new curve. Cool? So our short run equilibrium, the main takeaway here is that it's not necessarily at the long run equilibrium where the 3 curves touch there. Cool? Alright. Let's go ahead and pause and let's talk a little bit more about these shifts and what happens in the short run equilibrium.

Here’s what students ask on this topic:

What is the AD-AS model and how does it determine equilibrium in the short run and long run?

The AD-AS model, or Aggregate Demand-Aggregate Supply model, is a macroeconomic tool used to analyze the relationship between total demand and total supply in an economy. In the long run, equilibrium occurs where the aggregate demand (AD), short-run aggregate supply (SRAS), and long-run aggregate supply (LRAS) curves intersect. This intersection determines the equilibrium price level and GDP. In the short run, equilibrium may differ due to shifts in AD or SRAS, leading to a new intersection point. These shifts can result from various factors such as changes in consumer confidence, government policies, or external shocks, impacting price levels and GDP.

How do shifts in aggregate demand affect short-run and long-run equilibrium in the AD-AS model?

Shifts in aggregate demand (AD) can significantly impact both short-run and long-run equilibrium in the AD-AS model. In the short run, a shift in AD, either to the left or right, will change the intersection point with the short-run aggregate supply (SRAS) curve, leading to a new short-run equilibrium with different price levels and GDP. For example, a leftward shift in AD typically results in lower price levels and GDP. In the long run, the economy will adjust, and the new equilibrium will be where the AD curve intersects with both the SRAS and long-run aggregate supply (LRAS) curves, restoring the economy to its potential output level.

What causes shifts in the short-run aggregate supply curve in the AD-AS model?

Shifts in the short-run aggregate supply (SRAS) curve can be caused by various factors. These include changes in input prices (e.g., wages, raw materials), supply shocks (e.g., natural disasters, technological advancements), and changes in expectations about future prices. For instance, an increase in wages or raw material costs can shift the SRAS curve to the left, indicating a decrease in supply at each price level. Conversely, technological improvements can shift the SRAS curve to the right, indicating an increase in supply. These shifts affect the short-run equilibrium, altering the price level and GDP.

What is the difference between short-run and long-run aggregate supply in the AD-AS model?

In the AD-AS model, short-run aggregate supply (SRAS) and long-run aggregate supply (LRAS) differ in their responsiveness to price changes. The SRAS curve is upward sloping, indicating that as prices increase, the quantity of goods and services supplied also increases, due to factors like fixed wages and prices in the short run. In contrast, the LRAS curve is vertical, reflecting that in the long run, the economy's output is determined by factors such as technology, resources, and labor, rather than price levels. The LRAS represents the economy's potential output, where all resources are fully employed.

How do external shocks impact the AD-AS model and economic equilibrium?

External shocks, such as natural disasters, geopolitical events, or significant changes in global markets, can impact the AD-AS model by shifting either the aggregate demand (AD) or short-run aggregate supply (SRAS) curves. For example, a natural disaster might reduce the SRAS by damaging infrastructure, leading to higher prices and lower GDP in the short run. Conversely, a positive external shock, like a technological breakthrough, can increase SRAS, lowering prices and increasing GDP. These shifts alter the short-run equilibrium, and the economy will eventually adjust to a new long-run equilibrium where AD, SRAS, and long-run aggregate supply (LRAS) intersect.