What Short-Run Equilibrium Means
The AD-AS model brings together two relationships: aggregate demand (AD), which shows the real output demanded at different price levels, and short-run aggregate supply (SRAS), which shows the real output firms plan to produce at different price levels in the short run. Their intersection identifies the price level and real output at which those plans are consistent.
This is a model equilibrium, not a claim that every firm or household is individually in balance. It is an aggregate condition: at the equilibrium price level, the quantity of real output demanded equals the quantity supplied. The earlier material on aggregate demand and supply established how to read these curves; here the focus is identifying their short-run equilibrium and interpreting its position relative to potential output.
In the standard diagram, the vertical axis measures the price level \(P\), and the horizontal axis measures real output \(Y\). The AD and SRAS curves cross at \((P_e,Y_e)\). Potential output \(Y^*\) is shown by a vertical long-run aggregate supply (LRAS) line. The intersection of AD and SRAS determines short-run equilibrium; the location of the LRAS line is used to compare that equilibrium output with potential.
Here \(Y_D(P)\) denotes the real output demanded at price level \(P\), while \(Y_S(P)\) denotes the real output supplied in the short run. The equality applies at the equilibrium price level \(P_e\); it does not say that demand equals supply at every price level.
Why the Intersection Is the Equilibrium
At any particular price level, compare the quantity of output demanded with the quantity supplied. If they differ, the economy is not at the point where the plans of buyers and producers match. In the model, the intersection is the price-output combination for which the difference is zero.
Read the output demanded from AD and the output supplied from SRAS at that same price level.
If demanded output exceeds supplied output, the plans do not match. If supplied output exceeds demanded output, they also do not match.
At the AD-SRAS intersection, the two quantities are equal. The corresponding price level and output are \(P_e\) and \(Y_e\).
This reasoning is also why the curves must be compared at the same price level. Comparing the output demanded at one price with the output supplied at a different price cannot establish equilibrium. In a diagram, the intersection makes the comparison visually; in a schedule, it must be made row by row at matching price levels.
The equation is a concise equilibrium condition: at \(P_e\), the excess of demanded over supplied output is zero. Away from the intersection, that difference is nonzero, so the selected price-output pair is not the short-run equilibrium. This is a condition for identifying equilibrium, not a complete account of how prices adjust over time.
Worked Examples: Finding and Interpreting Equilibrium
Worked Example: Finding the Matching Row in an AD-AS Schedule
A hypothetical economy has the following schedule. Real output is measured in thousands of units. Identify the short-run equilibrium and compare its output with potential output of 1,050 thousand units.
| Price level | Output demanded | Output supplied |
|---|---|---|
| 90 | 1,200 | 800 |
| 100 | 1,100 | 1,000 |
| 110 | 1,000 | 1,200 |
| 120 | 900 | 1,400 |
Method: compare demanded and supplied output at each listed price level. At a price level of 90, the difference is \(1{,}200-800=400\) thousand units. At 100, it is \(1{,}100-1{,}000=100\) thousand. At 110, it is \(1{,}000-1{,}200=-200\) thousand. At 120, it is \(900-1{,}400=-500\) thousand.
None of those differences is zero, so this schedule as written does not list an exact matching row. It shows that the equilibrium is not at any of the four listed price levels. The differences change sign between 100 and 110, which indicates that the curves cross between those listed levels if the curves vary continuously. Without additional curve information, the exact equilibrium price and output cannot be read from this schedule.
The given potential output of 1,050 thousand units does not supply the missing intersection coordinates. It only provides a reference for comparing output once the equilibrium output is known. Common mistake avoided: selecting the closest row (price level 100) and calling it equilibrium, even though its demanded and supplied quantities differ by 100 thousand units.
Worked Example: Identifying Equilibrium and Comparing with Potential
For a hypothetical economy, the quantities in the table are measured in thousands of units. Find the equilibrium and state how its output compares with potential output of 1,250 thousand units.
| Price level | Output demanded | Output supplied |
|---|---|---|
| 80 | 1,400 | 1,000 |
| 100 | 1,200 | 1,200 |
| 120 | 1,000 | 1,400 |
Method: locate the row where the two quantities are equal. At price level 80, demanded output exceeds supplied output by \(1{,}400-1{,}000=400\) thousand units. At price level 100, both are 1,200 thousand units. At price level 120, supplied output exceeds demanded output by \(1{,}400-1{,}000=400\) thousand units.
The equality occurs at price level 100, so \(P_e=100\) and \(Y_e=1{,}200\) thousand units. Compare equilibrium output with potential: \(1{,}200-1{,}250=-50\) thousand units. Thus equilibrium output is 50 thousand units below potential output.
Check: At the identified price level, both schedule entries are 1,200, satisfying \(Y_D(P_e)=Y_S(P_e)\). Common mistake avoided: treating the price level itself as output. The price level is 100; the real output at the intersection is 1,200 thousand units.
Worked Example: Reading the Intersection on a Diagram
A diagram for a hypothetical economy has price level on the vertical axis and real output in millions of units on the horizontal axis. The drawn AD and SRAS curves cross at the plotted coordinate \((Y,P)=(2.4,112)\). The LRAS line is at \(Y^*=2.2\) million units. State the short-run equilibrium and compare its output with potential.
Method: read the coordinates in the order specified by the axes. The horizontal coordinate is output, so \(Y_e=2.4\) million units. The vertical coordinate is the price level, so \(P_e=112\). Therefore the equilibrium pair is \((P_e,Y_e)=(112,2.4\text{ million units})\).
Next compare the two output levels using the same units: \(2.4-2.2=0.2\) million units. Since 0.2 million equals 200,000, equilibrium output is 200,000 units above potential output.
Check: The point used is where AD crosses SRAS, and the comparison uses output coordinates only. Common mistake avoided: reading the LRAS value as the short-run equilibrium output. LRAS marks potential output at 2.2 million; the AD-SRAS intersection gives actual short-run equilibrium output at 2.4 million.
Interpreting Equilibrium Relative to Potential Output
Once the AD-SRAS intersection has been identified, compare its horizontal coordinate \(Y_e\) with potential output \(Y^*\). The comparison is about real output, not the price level. The three possible positions are:
| Comparison | Interpretation |
|---|---|
| \(Y_e<Y^*\) | Short-run equilibrium output is below potential output. |
| \(Y_e=Y^*\) | Short-run equilibrium output equals potential output. |
| \(Y_e>Y^*\) | Short-run equilibrium output is above potential output. |
This comparison does not change the definition of short-run equilibrium. For example, \(Y_e<Y^*\) can still be an equilibrium: AD and SRAS intersect at a particular point even though that point's output is below potential. Potential output is a benchmark for sustainable production, not a requirement that short-run output must equal it.
The price level also has a distinct role. It is the vertical coordinate of the AD-SRAS intersection, whereas \(Y_e\) and \(Y^*\) are quantities of real output. A higher price-level coordinate does not, by itself, tell you whether equilibrium output is above or below potential. Read and compare the output values directly.
Common Traps
- Calling any point on AD or SRAS an equilibrium. A point on just one curve does not show that demanded and supplied output match. The short-run equilibrium must lie on both curves.
- Comparing quantities at different price levels. Demand and supply must be compared at the same price level. Otherwise the equality condition is not being tested.
- Confusing potential output with short-run equilibrium output. \(Y^*\) comes from LRAS; \(Y_e\) comes from the AD-SRAS intersection. They may be equal, but need not be.
- Swapping the axes. In the standard diagram, output is horizontal and the price level is vertical. Read the plotted coordinates using the axis labels rather than assuming their order.
- Assuming a nearby schedule row is an exact equilibrium. A small difference is still a difference. If no row has equal quantities, report that the exact intersection is not provided rather than labeling an unequal row an equilibrium.
Check Your Understanding
For each problem, identify the equilibrium condition before comparing output with potential.
- A schedule reports that at price level 70, output demanded is 900 thousand units and output supplied is 900 thousand units. Potential output is 950 thousand units. State the short-run equilibrium and its position relative to potential. (Answer: \(P_e=70\), \(Y_e=900\) thousand units; output is 50 thousand units below potential.)
- At price level 105, a hypothetical economy's output demanded is 1,600 thousand units and output supplied is 1,520 thousand units. Is this point a short-run equilibrium? Calculate the difference and state which quantity is larger. (Answer: No; demanded output exceeds supplied output by 80 thousand units.)
- A diagram's AD-SRAS intersection is at output 3.1 million units and price level 118. Potential output is 3.4 million units. Report the equilibrium pair and compare output with potential in thousands of units. (Answer: \((P_e,Y_e)=(118,3.1\text{ million units})\); output is 300 thousand units below potential.)
- A table gives the following values at price levels 90, 100, and 110: demanded output is 1,300, 1,200, and 1,100; supplied output is 900, 1,200, and 1,500, respectively. All outputs are in thousands of units. Potential output is 1,150 thousand units. Find equilibrium and compare it with potential. (Answer: \(P_e=100\), \(Y_e=1,200\) thousand units; output is 50 thousand units above potential.)
- A diagram shows LRAS at 2.8 million units. A student reports that the short-run equilibrium is at 2.8 million units because that is potential output, but the AD-SRAS curves actually intersect at 2.6 million units and price level 95. Correct the report and compare output with potential. (Answer: \(P_e=95\), \(Y_e=2.6\) million units; output is 0.2 million, or 200,000 units, below potential.)