Question

How is the natural rate of unemployment illustrated in an AD/AS model?

Short answer

The natural rate of unemployment is illustrated in an AD/AS model by finding the intersection point between the Aggregate Demand (AD) curve and the Long-Run Aggregate Supply (LRAS) curve. This equilibrium point represents the potential output level where the economy is operating at full employment, and the unemployment rate equals the natural rate of unemployment.

Step-by-step solution

Understanding AD/AS Model

The AD/AS model is a standard macroeconomic model used to depict the equilibrium level of real GDP and price level in the economy. In this model, Aggregate Demand (AD) represents the total demand for goods and services in an economy, while Aggregate Supply (AS) represents the total supply of goods and services by producers. When Aggregate Demand and Aggregate Supply are equal, this represents the equilibrium price level and real GDP in the economy.

Natural Rate of Unemployment

The natural rate of unemployment is the rate of unemployment that exists when the economy is at full employment or its potential output level. It is the long-run unemployment rate that occurs due to the normal turnover of workers in the labor market, which includes frictional and structural unemployment. In the AD/AS model, the natural rate of unemployment occurs when the economy is operating at its potential output level, where Aggregate Demand equals the Long-Run Aggregate Supply.

Identifying LRAS

The first step in illustrating the natural rate of unemployment in an AD/AS model is identifying the Long-Run Aggregate Supply curve (LRAS). The LRAS curve is a vertical line at the level of potential output or full employment output in the economy. It represents the level of output that the economy can produce when resources, including labor, are fully employed.

Identifying the Natural Rate of Unemployment on the AD/AS Model

To illustrate the natural rate of unemployment, we need to find the point where AD intersects the LRAS curve. This intersection represents the equilibrium level of real GDP and the price level when the economy is operating at its potential output level. At this point, the unemployment rate is equal to the natural rate of unemployment. When AD is equal to LRAS, the economy is at full employment, and the natural rate of unemployment occurs.

Graphical Representation

To show the natural rate of unemployment in the AD/AS model graphically, follow these steps: 1. Draw the AD curve, which slopes downward, representing the relationship between the price level and the quantity of real GDP demanded. 2. Draw the LRAS curve as a vertical line at the level of potential output or full employment output. 3. Identify the point where the AD curve intersects the LRAS curve. This point represents the equilibrium price level and real GDP when the economy is operating at its potential output level. 4. The unemployment rate at this equilibrium point represents the natural rate of unemployment. In conclusion, the natural rate of unemployment is illustrated in an AD/AS model by identifying the point where the Aggregate Demand curve intersects the Long-Run Aggregate Supply curve. At this equilibrium point, the economy is operating at its potential output level, and the unemployment rate represents the natural rate of unemployment.