#AP Macroeconomics: Long-Run Adjustment - Your Night-Before Guide

Hey! Let's make sure you're totally prepped for the exam. We're diving into how the economy self-corrects, which is super important. Remember, the economy always wants to get back to its long-run equilibrium. Let's get started!

#Understanding Long-Run Equilibrium

• The economy tends to self-correct back to long-run equilibrium after short-run shocks. This is primarily through price adjustments.
• Think of it as the economy's natural tendency to find balance. ⚖️

#Economic Shocks

• Shocks are unexpected events that shift the AD curve. These shifts only affect output and unemployment in the short run.
• In the long run, the economy adjusts back to its full-employment level of output.

-   This is like shrinking the economy's production possibilities. 📉

• Only an increase in LRAS (expanding resources) leads to greater output in the long run.

  • Remember, it's about the economy's resources, not just AD or SRAS. 💡

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• The economy has self-correcting mechanisms and does not always require government intervention. This is why it is important to understand how it works.

#Self-Correction Mechanisms

Let's walk through how the economy self-corrects after short-run imbalances. We'll look at recessionary and inflationary gaps.

#Recessionary Gap

• A recessionary gap occurs when the economy is producing below its full potential. Equilibrium is to the left of the LRAS.

  • Think of it like the economy isn't using all its resources efficiently. 😩

• Key Characteristics:

  • Equilibrium output is less than full-employment output.
  • Unemployment is higher than the natural rate.

• Self-Correction Process:

  • High unemployment puts downward pressure on wages.

  • Lower wages reduce production costs for firms.

  • This causes SRAS to shift to the right, increasing output and decreasing the price level.

    • The economy moves back to long-run equilibrium. ➡️

  

  Caption: The economy self-corrects from a recessionary gap (B) by shifting SRAS to the right.

#Inflationary Gap

• An inflationary gap occurs when the economy is producing above its full potential. Equilibrium is to the right of the LRAS.

  • Think of it like the economy is overworking its resources. 🥵

• Key Characteristics:

  • Equilibrium output is greater than full-employment output.
  • Unemployment is lower than the natural rate.

• Self-Correction Process:

  • Low unemployment puts upward pressure on wages.

  • Higher wages increase production costs for firms.

  • This causes SRAS to shift to the left, decreasing output and increasing the price level.

    • The economy moves back to long-run equilibrium. ⬅️

  

  Caption: The economy self-corrects from an inflationary gap (B) by shifting SRAS to the left.

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• Remember, these self-correcting mechanisms are about price and wage flexibility.
• Understand how shifts in AD and SRAS affect output, unemployment, and the price level in the short run and how the economy adjusts in the long run.

#Final Exam Focus

• Highest Priority Topics:

  • Long-run aggregate supply (LRAS) and its determinants.
  • Short-run aggregate supply (SRAS) and its shifters.
  • Aggregate demand (AD) and its components.
  • Recessionary and inflationary gaps and how the economy self-corrects.

• Common Question Types:

  • Graphing AD, SRAS, and LRAS shifts.
  • Explaining the short-run and long-run effects of economic shocks.
  • Analyzing the impact of fiscal and monetary policies.

• Last-Minute Tips:

  • Time Management: Quickly identify the type of gap (recessionary or inflationary) and focus on the self-correction process.
  • Common Pitfalls: Misinterpreting shifts in the curves; confusing short-run and long-run effects.
  • Strategies: Draw diagrams to visualize the shifts and use the self-correction process to explain the long-run adjustment.

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Practice Question

Practice Questions

#Multiple Choice Questions

1. Which of the following would cause a shift to the left of the long-run aggregate supply curve? (A) An increase in the price level (B) A decrease in the capital stock (C) An increase in government spending (D) A decrease in the money supply (E) An increase in consumer confidence

2. If the economy is experiencing an inflationary gap, which of the following will most likely occur in the long run? (A) A decrease in the price level and a decrease in real output (B) A decrease in the price level and an increase in real output (C) An increase in the price level and a decrease in real output (D) An increase in the price level and an increase in real output (E) No change in the price level or real output

3. Which of the following is true of the long-run aggregate supply curve? (A) It is horizontal at the full-employment level of output. (B) It is vertical at the full-employment level of output. (C) It slopes upward to the right. (D) It slopes downward to the right. (E) It shifts to the left when the price level increases.

#Free Response Question

Assume the economy is currently in long-run equilibrium.

(a) Draw a correctly labeled graph of the long-run aggregate supply, short-run aggregate supply, and aggregate demand curves, showing the equilibrium price level and output.

(b) Assume there is a significant increase in consumer confidence. On your graph in part (a), show the effect of this change on the aggregate demand curve. Label the new short-run equilibrium as point B.

(c) Explain the short-run effects of the change in consumer confidence on the price level and real output.

(d) Explain how the economy will adjust in the long run to return to full employment. Show this long-run adjustment on your graph in part (a).

Scoring Guidelines:

(a) Graph (3 points): - 1 point for correctly labeled axes (price level and real output). - 1 point for correctly drawn LRAS, SRAS, and AD curves intersecting at the equilibrium. - 1 point for labeling the equilibrium price level and output.

(b) AD Shift (1 point): - 1 point for correctly shifting the AD curve to the right and labeling the new short-run equilibrium as point B.

(c) Short-Run Effects (2 points): - 1 point for stating that the price level increases. - 1 point for stating that real output increases.

(d) Long-Run Adjustment (3 points): - 1 point for stating that wages will increase due to low unemployment. - 1 point for stating that the SRAS curve will shift to the left. - 1 point for showing the SRAS curve shifting to the left such that the new equilibrium is back on the LRAS curve.