Question

How is the natural rate of unemployment

illustrated in an AD/AS model?

Short answer

The natural rate of unemployment is the lowest rate of unemployment when the labor and goods markets are in balance.

Step-by-step solution

Introduction

The aggregate demand–aggregate supply model, also known as the AD–AS model, is a macroeconomic model that explains price levels and production by examining the link between aggregate demand (AD) and aggregate supply (AS).

Explanation

The AD curve crosses the SRAS curve in the diagram above. Because there is a large disparity between current GDP and potential GDP, equilibrium is achieved at $E_0$, price level at $P_0$, and real GDP at $Y_0$.

The AD curve changes rightwards from $AD0$to $AD1$as aggregate demand rises. New equilibrium is reached at $E_1$when the new AD curve intersects with the SRAS curve. The intersection of the New AD curve with the SRAS results in a greater level of output, which signifies a higher rate of employment.

Because the new equilibrium is close to potential GDP, it leads to higher output and a natural rate of unemployment, which exists even at full employment in the long run.