THE ECONOMICS OF MONEY,BANKING, AND FINANCIAL MARKETS 661

CHAPTER 24

Aggregate Demand and Supply Analysis
AS3

LRAS

Aggregate
Price Level, P

629

AS2

P3

3

AS1
2

P2
P1

1

AD

Yn

Y2

Y1
Aggregate Output, Y
(a) Initial short-run equilibrium in which Y > Yn

LRAS

Aggregate
Price Level, P

AS1
AS2
AS3

P1

1

P2

2
3

P3

AD
Y1

Y2

Yn

Aggregate Output, Y
(b) Initial short-run equilibrium in which Y < Yn

FIGURE 24-5

Adjustment to Long-Run Equilibrium in Aggregate Supply
and Demand Analysis

In both panels, the initial equilibrium is at point 1 at the intersection of AD and AS1. In panel
(a), Y1 Yn, so the short-run aggregate supply curve keeps shifting to the left until it reaches
AS3, where output has returned to Yn. In panel (b), Y1 Yn, so the short-run aggregate supply
curve keeps shifting to the right until output is again returned to Yn. Hence in both cases,
the economy displays a self-correcting mechanism that returns it to the natural rate level of
output.

level, Yn, wages continue to be driven up, eventually shifting the aggregate supply curve to AS3. The equilibrium reached at point 3 is on the vertical long-run
aggregate supply curve (LRAS ) at Yn and is a long-run equilibrium. Because output is at the natural rate level, there is no further pressure on wages to rise and
thus no further tendency for the aggregate supply curve to shift.
The movements in panel (a) indicate that the economy will not remain at a level
of output higher than the natural rate level because the short-run aggregate supply
curve will shift to the left, raise the price level, and cause the economy (equilibrium)
to slide upward along the aggregate demand curve until it comes to rest at a point
on the long-run aggregate supply curve at the natural rate level of output Yn.
In panel (b), the initial equilibrium at point 1 is one at which output Y1 is below
the natural rate level. Because unemployment is higher than the natural rate,