key term - Long-Run Aggregate Supply (LRAS)

Definition

The long-run aggregate supply (LRAS) curve represents the maximum level of real output that an economy can produce at full employment, given the existing production technology, factor inputs, and institutional constraints. It depicts the relationship between the overall price level and the economy's total output in the long run, when all factors of production can be adjusted.

5 Must Know Facts For Your Next Test

1. The LRAS curve is vertical, indicating that output is determined by the economy's production capacity and is independent of the price level in the long run.
2. The LRAS curve shifts to the right when there are increases in the quantity or quality of factors of production, such as capital, labor, or technology.
3. Economic growth, which increases the productive capacity of an economy, causes the LRAS curve to shift rightward over time.
4. The position of the LRAS curve determines the economy's potential GDP, which is the maximum sustainable level of output that can be produced at full employment.
5. The neoclassical perspective emphasizes the role of the LRAS curve in determining the long-run equilibrium level of output and employment in the economy.

Review Questions

• Explain how the LRAS curve relates to the concept of potential GDP.
  • The LRAS curve represents the maximum level of real output that an economy can produce at full employment, given its available resources and technology. This level of output is known as potential GDP. The position of the LRAS curve determines the economy's potential GDP, which is the sustainable level of output when all factors of production are fully utilized. Shifts in the LRAS curve, driven by changes in the quantity or quality of factors of production, lead to changes in the economy's potential GDP.
• Describe how the LRAS curve is incorporated into the AD/AS model and how it relates to economic growth and inflation.
  • In the AD/AS model, the LRAS curve represents the long-run relationship between the price level and real output. The LRAS curve is vertical, indicating that output is determined by the economy's production capacity and is independent of the price level in the long run. Shifts in the LRAS curve, caused by changes in factors of production or technological progress, lead to changes in the economy's potential GDP. These shifts can affect the long-run equilibrium level of output and employment, as well as the rate of inflation, as the economy moves along the LRAS curve.
• Analyze the policy implications of the neoclassical perspective, which emphasizes the role of the LRAS curve in determining the long-run equilibrium level of output and employment.
  • The neoclassical perspective, which focuses on the LRAS curve, suggests that in the long run, the economy will naturally return to its potential GDP, or full employment level of output. This implies that government policies aimed at increasing aggregate demand, such as fiscal or monetary stimulus, will only have temporary effects on output and employment. Instead, the neoclassical view emphasizes the importance of policies that increase the economy's productive capacity, such as investments in education, infrastructure, and technology, as these will shift the LRAS curve rightward and lead to sustainable increases in potential GDP. The neoclassical perspective also suggests that attempts to maintain output above the economy's potential, through demand-side policies, will only result in higher inflation without any long-term gains in employment or output.

Related terms

Aggregate Supply (AS):

The total quantity of goods and services that firms are willing to sell at different price levels in a given time period.

Short-Run Aggregate Supply (SRAS):

The relationship between the price level and the quantity of output supplied in the short run, when at least one factor of production is fixed.

Potential GDP:

The level of real GDP that an economy can produce at full employment, using its available resources and technology.