How do aggregate demand and aggregate supply determine output, the price level, and output gaps?
Topic 3.5 Equilibrium in the AD-AS Model: locate short-run and long-run macroeconomic equilibrium, and identify recessionary and inflationary output gaps.
A focused answer to AP Macroeconomics Topic 3.5, covering short-run and long-run macroeconomic equilibrium, the relationship between short-run equilibrium and full-employment output, and how to identify recessionary and inflationary output gaps on the AD-AS graph, with a worked question.
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What this topic is asking
Topic 3.5 brings the three curves together. The College Board wants you to find short-run and long-run macroeconomic equilibrium on the AD-AS graph and to identify output gaps: recessionary or inflationary. This is the diagnostic step before any policy question.
Short-run and long-run equilibrium
In long-run equilibrium the economy is producing exactly at potential: there is no output gap, cyclical unemployment is zero, and the actual unemployment rate equals the natural rate.
Output gaps
When short-run equilibrium output differs from full-employment output, the economy has an output gap. You measure it as the horizontal gap between short-run output and the vertical LRAS.
These gaps are exactly the booms and busts of the business cycle from Unit 2, seen in the AD-AS model. They tell you which way fiscal or monetary policy needs to push: a recessionary gap calls for expansion; an inflationary gap calls for contraction.
Try this
Q1. In long-run equilibrium, how does short-run output compare with full-employment output? [1 point]
- Cue. They are equal; the output gap is zero.
Q2. An economy has a recessionary gap. Is unemployment above or below the natural rate? [1 point]
- Cue. Above the natural rate (cyclical unemployment is positive).
Exam-style practice questions
Practice questions written in the style of College Board exam questions on this dot point, with worked answer explainers. The year tag is the paper they imitate, not the source.
AP 2019 (style)1 marksMultiple choice. An economy is in short-run equilibrium with real output below full-employment output. This economy is experiencing (A) an inflationary gap and rising prices. (B) a recessionary gap and unemployment above the natural rate. (C) long-run equilibrium. (D) an inflationary gap and unemployment below the natural rate. (E) full employment.Show worked answer →
The answer is (B). When short-run equilibrium output is below full-employment (potential) output, the economy has a recessionary (contractionary) gap, and unemployment is above the natural rate because cyclical unemployment is positive.
(A) and (D) describe an inflationary gap (output above potential). (C) and (E) describe long-run equilibrium, where output equals potential. Only (B) matches output below potential.
AP 2022 (style)5 marksFree response. (a) Draw a correctly labelled AD-AS graph showing an economy in short-run equilibrium with a recessionary gap; clearly mark full-employment output. (b) Identify the size and type of the output gap on your graph. (c) State what is true of cyclical unemployment in this economy. (d) Now draw a second graph showing an economy in long-run equilibrium. (e) State the relationship between short-run output and full-employment output in long-run equilibrium.Show worked answer →
A 5-point graphing FRQ.
(a) Graph (1 point): vertical LRAS at , downward-sloping AD and upward-sloping SRAS crossing at output to the left of , at price level .
(b) Gap (1 point): a recessionary gap equal to the horizontal distance .
(c) Cyclical unemployment (1 point): it is positive (unemployment is above the natural rate).
(d) Long-run graph (1 point): AD, SRAS, and LRAS all intersect at one point on the LRAS, with output equal to .
(e) Relationship (1 point): in long-run equilibrium short-run output equals full-employment output (the output gap is zero).
Markers reward output left of , the labelled gap, positive cyclical unemployment, and all curves meeting on LRAS.
Related dot points
- Topic 3.1 Aggregate Demand: define aggregate demand, explain the wealth, interest-rate, and exchange-rate effects that make it downward sloping, and identify the determinants that shift it.
A focused answer to AP Macroeconomics Topic 3.1, covering the definition of aggregate demand, the three reasons it slopes downward (the wealth, interest-rate, and exchange-rate effects), the components C plus I plus G plus net exports, and the determinants that shift the curve, with a worked graphing question.
- Topic 3.3 Short-Run Aggregate Supply: explain why the short-run aggregate supply curve slopes upward using sticky wages and prices, and identify the determinants that shift it.
A focused answer to AP Macroeconomics Topic 3.3, covering the upward slope of short-run aggregate supply, sticky wages and prices and misperceptions, supply shocks, and the determinants that shift SRAS, with a worked graphing question.
- Topic 3.4 Long-Run Aggregate Supply: explain why the long-run aggregate supply curve is vertical at full-employment (potential) output, and identify what shifts it.
A focused answer to AP Macroeconomics Topic 3.4, covering the vertical long-run aggregate supply curve, full-employment and potential output, the natural rate of unemployment, the link to the production possibilities curve, and the determinants of long-run growth, with a worked question.
- Topic 3.6 Changes in the AD-AS Model in the Short Run: trace how shifts in aggregate demand or short-run aggregate supply change the price level, real output, and unemployment in the short run.
A focused answer to AP Macroeconomics Topic 3.6, covering demand shocks and supply shocks in the short run, their effects on the price level, real output, and unemployment, and how to read the resulting output gaps, with a worked graphing question.
- Topic 2.7 Business Cycles: describe the phases of the business cycle, relate them to real GDP, unemployment, and inflation, and explain expansionary and recessionary output gaps relative to potential output.
A focused answer to AP Macroeconomics Topic 2.7, covering the phases of the business cycle (expansion, peak, recession, trough), real GDP fluctuations around potential output, recessionary and inflationary gaps, and how unemployment and inflation move over the cycle, with worked analysis.
Sources & how we know this
- AP Macroeconomics Course and Exam Description — College Board (2023)