AP Economics: Long Run vid 1 Adjustment

Long run self adjustment refers to the economy's ability to adjust naturally over time without government intervention.
It is crucial to understand its relationship to the aggregate demand and aggregate supply (ADAS) model.
Roots in classical economic theory which posits that:
- Prices and wages are completely flexible.
- Aggregate Supply (AS) curve is completely vertical.

Classical economics claims that shifts in aggregate demand (C, I, G, NX) lead to automatic price and wage adjustments.
Characteristics:
- Vertical Aggregate Supply Curve:
- No Short Run Aggregate Supply (SRAS) or Long Run Aggregate Supply (LRAS).
- Reflects the theory that changes in demand do not affect real output in the long run.
Critique:
- This theory has not held up during economic crises like the Great Depression of the 1930s.

The global depression of the 1930s led to alternative economic schools of thought that advocated for policy actions to manage economic problems.
Future discussion in Topic 3.8 will cover these policy actions.

In the context of long run self adjustment:
- Businesses and workers adjust their price and wage expectations based on current economic conditions.
- The modern approach utilizes both SRAS and LRAS curves to integrate various economic theories.

Short Run Aggregate Supply Curve (SRAS):
- Upward sloping due to wages and prices not being completely flexible in the short term.
Long Run Aggregate Supply Curve (LRAS):
- Vertical, indicating that in the long run, output is dependent entirely on resources (land, labor, capital).
- The long run curve under self-adjustment does not shift unless influenced by changes in resources or technologyie, things that shift the production possibilities curve.

Starting Point: Assume an economic situation is in long run equilibrium.
Positive Aggregate Demand Shock:
- Result: Aggregate demand increases, moving the economy beyond full employment (short run equilibrium).
- Result: SRAS shifts left to return to long run equilibrium.
Negative Scenario: Recessionary gap occurs below full employment output.
- SRAS will increase (shift right) to restore alignment with LRAS at full employment.
Inflationary Gap:
- SRAS will decrease (shift left) to correct the short run equilibrium that is beyond the LRAS.

Context: Economy of Artland operating above full employment (inflationary gap).
- If no policy actions are taken by the central bank or government, adjustments in the economy will occur naturally.
- An explicit note should be made about recognizing the absence of interventions leading to self-adjustment.
Key Language:
- Terms like "no policy actions taken" serve as cues for understanding self-adjustment scenarios.
- Businesses and workers adjust their conditions in response to the economic environment.

The graph depicts the economy's supply and demand curves under constant aggregate demand.
Confusion Point:
- Students often misinterpret equilibrium price levels by simply observing the graph.
Self-Adjustment Mechanism Explanation:
- If aggregate demand remains constant, the equilibrium price in the short run is at price level B.
- In the long run, SRAS will shift right until it aligns with LRAS. Leading to a new equilibrium price level A.
Correct Answer: Option choice B.

Key Takeaway: In long run self-adjustment, the economy corrects itself through the actions of businesses and workers, adjusting expectations based on prevailing economic conditions without policy intervention.
Important terminology to recognize includes concepts such as "long run self adjustment," "no policy action taken," and "the economy automatically adjusts."
Encouragement to engage with the next video for further exploration of related concepts.