3.7 Long-Run Self-Adjustment
With no policy action, flexible wages restore full employment: nominal wages fall in a recessionary gap (SRAS shifts right) and rise in an inflationary gap.
In a recessionary gap, unemployment above the natural rate eventually pushes nominal wages down as workers compete for scarce jobs. Lower wages cut production costs, shifting SRAS right until output returns to full employment — at a lower price level. No curve but SRAS moves.
In an inflationary gap, the overheated labor market bids nominal wages up, raising costs and shifting SRAS left until output falls back to potential at a higher price level. Either way, the economy ends where AD crosses LRAS.
The catch is speed: wages are sticky, especially downward, so self-correction out of a recession can take years. That is the Keynesian case for active fiscal policy (Topic 3.8) rather than waiting — while the classical view trusts the adjustment. Either way, output returns to potential; only the price level ends up different.
Key terms for 3.7
Drag the curves yourself — the fastest way to make 3.7 stick.
Showing self-adjustment by shifting AD or LRAS. Self-correction works entirely through nominal wages changing production costs — it is always the SRAS curve that shifts back toward full employment.
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