Equilibrium AD-AS Model: Your Night-Before-the-Exam Guide 🚀

Hey there, future AP Macro master! Let's make sure you're totally solid on the Aggregate Demand-Aggregate Supply (AD-AS) model. It's a cornerstone of the exam, so let's break it down and make it stick!

Aggregate Equilibrium: Short-Run vs. Long-Run

Think of aggregate equilibrium like supply and demand, but for the whole economy. We've got two key types:

• This is where the quantity of aggregate demand (AD) equals the quantity of aggregate supply (SRAS). It's shown by the intersection of the AD and SRAS curves. Just like in micro, but bigger!

  

Long-Run Equilibrium

• This happens when the current output is equal to the potential output (full employment). Graphically, it's where the AD, SRAS, and Long-Run Aggregate Supply (LRAS) curves all intersect. This is also called the full-employment level of real output.

Equilibrium Gaps: Inflationary vs. Recessionary

Sometimes, the economy isn't at its ideal long-run equilibrium. That's when we get gaps:

Surplus and Shortage in GDP

• Surplus: If the price level is above equilibrium, aggregate supply is greater than aggregate demand. 📉
• Shortage: If the price level is below equilibrium, aggregate demand is greater than aggregate supply. 📈

Recessionary Gap (Negative Output Gap)

• The short-run equilibrium is below the full-employment level. Think of it as the economy "falling behind." 📉
• Key Characteristics: High unemployment, low output.

Inflationary Gap (Positive Output Gap)

• The short-run equilibrium is above the full-employment level. Think of it as the economy "moving ahead." 📈

• Key Characteristics: Low unemployment, high output, potential for rising prices.

  

• Definition: The economy is producing more than its potential GDP.
• Why it's bad: Can lead to an "overheated" economy, driving up prices and decreasing purchasing power.
• Example: The U.S. economy in 2006, with low unemployment and high disposable income.

Recessionary Gap: Underperforming Economy

• Definition: The economy is producing less than its potential GDP.
• Why it's bad: Leads to higher unemployment and lower living standards.
• Example: The U.S. economy in 2005, with real GDP significantly below potential GDP.

Fixing the Gaps: Sneak Peek

• The Big Question: How do we get back to long-run equilibrium?
• Two Options:
  1. Self-Correction: Let the economy adjust on its own.
  2. Government Intervention: Use fiscal policy (more on this later!).

Final Exam Focus

• High-Priority Topics: AD-AS model, inflationary and recessionary gaps, understanding the graphical representation of equilibrium.
• Common Question Types:
  • Graphing shifts in AD and SRAS.
  • Identifying gaps and their effects.
  • Analyzing policy options to close the gaps.
• Time Management: Practice drawing the graphs quickly and accurately. Don't spend too much time on one question. Move on and come back if needed.
• Common Pitfalls: Confusing the direction of shifts, misinterpreting the gaps, and not understanding the relationship between the short-run and long-run.

Practice Question

Practice Questions

Multiple Choice Questions

1. Which of the following best describes the long-run equilibrium in the AD-AS model? (A) The intersection of AD and SRAS (B) The intersection of AD and LRAS (C) The intersection of AD, SRAS, and LRAS (D) The point where AD is at its maximum (E) The point where SRAS is at its maximum

2. An economy is experiencing a recessionary gap. Which of the following is most likely true? (A) The economy is producing beyond its potential output. (B) The unemployment rate is below the natural rate. (C) The short-run equilibrium is to the right of the LRAS. (D) The short-run equilibrium is to the left of the LRAS. (E) The economy is at full employment.

3. If the price level is above the equilibrium, which of the following is true? (A) Aggregate demand is greater than aggregate supply. (B) Aggregate supply is greater than aggregate demand. (C) The economy is in a recessionary gap. (D) The economy is in an inflationary gap. (E) The economy is in long-run equilibrium.

Free Response Question

Assume the economy is currently in a recessionary gap. Draw a correctly labeled graph of the AD-AS model showing the current equilibrium and the full-employment output. Then, explain the policy options available to the government to close the gap.

Scoring Guidelines:

1. Graph (4 points)
   • Correctly labeled axes (Price Level and Real GDP) - 1 point
   • Correctly drawn AD curve - 1 point
   • Correctly drawn SRAS curve - 1 point
   • Correctly drawn LRAS curve to the right of the AD and SRAS intersection - 1 point
2. Explanation (4 points)
   • Identification of the recessionary gap (output below potential) - 1 point
   • Explanation of fiscal policy options (increased government spending or reduced taxes) - 2 points
   • Explanation of how these policies will shift the AD curve to the right, closing the recessionary gap - 1 point