Long-Run Aggregate Supply vs Output Gap
Long-Run Aggregate Supply and Output Gap are related concepts in AP Economics that students often mix up. Long-run aggregate supply is the total supply of goods and services when all factors of production are fully employed. The output gap is the difference between actual real GDP and potential real GDP. Here is how they compare side by side.
In the long run, an economy's potential output is determined by its factors of production, such as labor, capital, and technology. Changes in the price level do not affect the quantity of goods and services supplied in the long run. The LRAS curve is vertical.
The output gap can be positive (an inflationary gap) or negative (a recessionary gap). It represents the amount by which an economy's actual output differs from its potential output. Policymakers often try to minimize the output gap.
LRAS vs the Output Gap: The Benchmark and the Distance From It
| Long-Run Aggregate Supply | Output Gap | |
|---|---|---|
| What it is on the diagram | A vertical line drawn at full-employment real GDP | The horizontal distance between equilibrium output and that line |
| What determines it | Resources, technology, capital and institutions, never the price level | Where aggregate demand and short-run aggregate supply happen to cross |
| How often it moves | Slowly, as productive capacity changes | Every time either short-run curve shifts |
| Effect of a rightward AD shift | None at all | Moves toward the positive side, closing a recessionary gap or opening an inflationary one |
| Sign | Not signed, since it is a level of output | Negative below potential and positive above it |
| What it says about unemployment | Unemployment equals the natural rate anywhere on this line | Its size and sign give the amount of cyclical unemployment |
| Policy that changes it | Long-run growth policy: investment, education, technology, institutions | Demand-side policy in the short run, plus self-correction over time |
The line stays put while the gap moves underneath it
Set long-run aggregate supply at 700 billion dollars in an illustrative economy, the level of output produced when labor and capital are fully employed. Aggregate demand and short-run aggregate supply cross at 665 billion dollars, so the output gap is negative 35 billion dollars, a shortfall of 5 percent of potential, and unemployment sits above the natural rate. Now let expansionary policy push aggregate demand right until the intersection lands at 714 billion dollars. The output gap flips to positive 14 billion dollars, or 2 percent of potential, and the labor market becomes tight. Across both scenarios the long-run curve never moved. It was 700 billion dollars before the policy and 700 billion dollars after it, because demand policy changes where the economy sits and not what the economy is capable of. This is the distinction students lose marks on. Shifting aggregate demand changes the gap. Shifting long-run aggregate supply changes the benchmark itself, which is economic growth rather than stabilization, and it requires more capital, more workers, better technology or better institutions. Both moves can be drawn at /sandbox/adas.
A gap closes on its own, though the mechanism is slow and unpopular
The model does not need policy to return output to the long-run line. Start from the 35 billion dollar shortfall. Unemployment above the natural rate means workers compete for scarce jobs, so nominal wages and other input prices drift down as contracts are renegotiated. Cheaper inputs shift short-run aggregate supply to the right, and the economy slides along aggregate demand toward higher output at a lower price level, until the intersection reaches the long-run line and the gap is gone. An economy above potential runs the same process in reverse, with input prices bid up until the short-run curve shifts left and output falls back. Notice what changes and what does not. Output returns to the same 700 billion dollars either way, so the long run fixes the quantity produced while demand fixes only the price level at which it is produced. The argument against waiting is speed. Wages fall slowly, especially downward, so the adjustment can take years of high unemployment, which is the standard case for acting rather than waiting. Growth, meaning a move in the line itself, is covered at /macro/economic-growth.
Frequently asked questions
Is LRAS the same as potential GDP?
Yes, in the AD-AS model the long-run aggregate supply curve is drawn as a vertical line at potential output, the level produced when the economy is at full employment. Potential output is the quantity and LRAS is the way that quantity appears on the diagram. The output gap is then measured from that line.
Does an output gap shift long-run aggregate supply?
No, an output gap describes where the economy is sitting relative to LRAS, so it cannot move the line it is measured against. Only changes in the quantity or quality of resources, in technology or in institutions shift LRAS. Demand shocks open and close gaps without touching potential output.
How does a recessionary gap close on its own?
High unemployment gradually pushes nominal wages and other input prices down, which shifts short-run aggregate supply right and moves output back toward potential at a lower price level. That is the self-correction mechanism in the AD-AS model. It works slowly, because wages resist falling, which is the main argument for using policy instead of waiting.
Live AD/AS Model graph. Drag the curves, or open the full version.
Get AP Econ exam tips in your inbox
Occasional emails with study tips, new interactive graphs, and exam-season reminders. Free, no spam.
No spam. Unsubscribe anytime. Read our privacy policy.
Keep track of what you have studied
A free EconLearn account adds progress tracking, your quiz history, and achievements. Studying here is free either way, and there is nothing to pay for as a student.
Create a free accountAlready have one? Sign in
Last updated