CHAPTER 24 Aggregate Demand and Supply Analysis AS3 LRAS Aggregate Price Level, P 629 AS2 P3 AS1 P2 P1 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 P2 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 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 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 is one at which output Y1 is below the natural rate level Because unemployment is higher than the natural rate,