Short Run Equilibrium

Putting AD and SRAS together, two curves will intercept at a point. This point is the short run equilibrium. This price level is the equilibrium price level, Pe; this quantity is the equilibrium quantity, Qe. At any other price level, the economy is either in surplus or in shortage.

Long Run Equilibrium

The interception point of AD and SRAS may be on the LRAS, creating a long run equilibrium where real GDP is equal to potential real GDP. If the potential GDP is at 600, then the following graph shows that the SR equilibrium is on the LRAS curve, creating a LR equilibrium.

However, short-run equilibrium (real GDP) may occur on a level above or below the potential GDP, creating a disequilibrium in the economy.

If real GDP < Potential real GDP (full employment GDP), then a recessionary gap exist. At the same time: Unemployment rate > natural rate of unemployment. Since more job seekers are in the market, they tend to settle with a lower wage. Lower wage will increase the AS curve, causing the price to decrease. Lower price will increase consumption. This process will continue until the economy reaches the long run equilibrium (potential real GDP).

If the potential GDP is at 700, the following graph presented a recessionary gap between SR equilibrium and the LRAS curve.

If real GDP > Potential real GDP (full employment GDP), then an inflationary gap exist. At the same time: Unemployment rate < natural rate of unemployment. Since job seekers are less than job openings in the market, employers are forced to raise the wage to attract new workers. High wage will decrease the AS, and raise the price. Higher price will lower consumption. This process will repeat until the long run equilibrium is reached.

If the potential GDP is at 500, the following graph presented an inflationary gap between SR equilibrium and the LRAS curve.