Where is the Long Run Aggregate Supply Curve?

Now we can answer the first part of the question: where is the Potential Output curve? It is at the NAIRGDP. In other words, the PO tells us that, in the long run, the amount produced at any price level will be the NAIRGDP.

Here is the reasoning:

By definition, the PO tells us the real GDP that can be profitably sold when supply is equal to demand in every market. Supply equal to demand means all prices are stable, and that means the overall average price level must also be zero. In turn, a stable price level means a rate of inflation of zero, which means the rate of inflation stays at zero -- it neither accelerates to positive inflation nor drops into price deflation. Therefore, production and unemployment must be at the non-accelerating inflation level, the NAIRGDP and NAIRU respectively.

Thinking in terms of "inflationary spirals," a stable price level means that costs and prices are staying in the same relation, and that only happens when unemployment is at the unique level at which labor costs neither push ahead of the price level nor fall behind it. Thinking in more "New Classical" terms, when the price level remains stable, people soon learn that it really is stable, and are not taken by surprise. Therefore, production and unemployment stay at the no-surprise level: the NAIRGDP and the NAIRU, respectively.

Interpretation of the NAIRU