Long-Run Equilibrium

Definition

Long-run equilibrium is a state in the economy where all markets have reached a point of balance, with no incentive for producers or consumers to change their behavior. It represents a stable, long-term condition where the aggregate supply and demand curves have fully adjusted to reach an equilibrium price and quantity.

5 Must Know Facts For Your Next Test

1. In the long-run equilibrium, all factor inputs, such as capital and labor, can be adjusted, allowing firms to produce at the most efficient level.
2. The long-run aggregate supply curve is vertical, indicating that output is determined by the economy's productive capacity rather than demand.
3. The long-run equilibrium is characterized by full employment, where the economy is operating at its potential output level.
4. Adjustments in the long-run equilibrium occur through changes in factor prices, such as wages and interest rates, which influence production decisions.
5. Policies aimed at affecting the long-run equilibrium typically focus on increasing the economy's productive capacity, such as through investments in infrastructure or education.

Review Questions

• Explain how the concept of long-run equilibrium is related to the model of aggregate demand and aggregate supply.
  • The long-run equilibrium in the aggregate demand and aggregate supply model represents a stable, long-term condition where the economy has fully adjusted to changes in factors such as technology, resource availability, and consumer preferences. In the long-run, the aggregate supply curve is vertical, indicating that output is determined by the economy's productive capacity rather than demand. The intersection of the aggregate demand and vertical aggregate supply curves determines the long-run equilibrium price and output level, which corresponds to the economy's potential output and full employment.
• Describe the key characteristics of the long-run equilibrium and how they differ from the short-run equilibrium.
  • The key characteristics of the long-run equilibrium include: 1) All factor inputs, such as capital and labor, can be adjusted, allowing firms to produce at the most efficient level; 2) The long-run aggregate supply curve is vertical, indicating that output is determined by the economy's productive capacity rather than demand; 3) The economy is operating at its potential output level, corresponding to full employment. In contrast, the short-run equilibrium is characterized by fixed factor inputs, a positively-sloped aggregate supply curve, and the possibility of underemployment or overemployment relative to the economy's productive capacity.
• Analyze how policies aimed at affecting the long-run equilibrium differ from those targeting the short-run equilibrium, and explain the potential implications of each approach.
  • Policies aimed at affecting the long-run equilibrium typically focus on increasing the economy's productive capacity, such as through investments in infrastructure, education, or research and development. These policies are designed to shift the long-run aggregate supply curve outward, leading to a higher potential output level and a new long-run equilibrium. In contrast, policies targeting the short-run equilibrium, such as changes in monetary or fiscal policy, are designed to shift the aggregate demand curve and influence the current level of output and employment. While short-run policies can provide immediate stabilization, long-run policies are essential for sustainable economic growth and improvements in living standards over time.

Related terms

Aggregate Demand:

The total demand for all goods and services in an economy at a given price level and time.

Aggregate Supply:

The total supply of all goods and services produced in an economy at a given price level and time.

Equilibrium Price:

The price at which the quantity demanded is equal to the quantity supplied, resulting in a stable market condition.