Long-Run Aggregate Supply

Definition

Long-run aggregate supply (LRAS) refers to the relationship between the price level and the economy's total output when all input prices and production technologies have fully adjusted. It represents the maximum level of real GDP that can be produced when all resources are fully employed and all input prices have had time to adjust to the prevailing economic conditions.

5 Must Know Facts For Your Next Test

1. The LRAS curve is vertical, indicating that the level of real GDP is independent of the price level in the long run.
2. The position of the LRAS curve is determined by the economy's production capabilities, including the available technology, capital stock, and labor force.
3. Shifts in the LRAS curve are caused by changes in the underlying factors of production, such as changes in the labor force, capital stock, or technology.
4. The LRAS model assumes that in the long run, the economy will always return to its full-employment level of output, regardless of the level of aggregate demand.
5. The LRAS model is a key component of the AD-AS model, which is used to analyze the determination of the price level and real GDP in the economy.

Review Questions

• Explain how the long-run aggregate supply (LRAS) curve differs from the short-run aggregate supply (SRAS) curve.
  • The key difference between the LRAS and SRAS curves is the time horizon. The SRAS curve is upward-sloping, reflecting the fact that in the short run, at least one input price is fixed, and firms can only increase output by raising prices. In contrast, the LRAS curve is vertical, indicating that in the long run, when all input prices have had time to adjust, the level of real GDP is independent of the price level. The LRAS curve represents the maximum level of real GDP that can be produced when all resources are fully employed and all input prices have had time to adjust to the prevailing economic conditions.
• Describe how shifts in the LRAS curve impact the economy in the AD-AS model.
  • Shifts in the LRAS curve represent changes in the economy's production capabilities, which can be caused by factors such as changes in the labor force, capital stock, or technology. An increase in the LRAS curve, indicating an expansion of the economy's productive capacity, will shift the vertical LRAS curve to the right. This shift will increase the economy's potential output and, in the long run, lead to a lower price level and higher real GDP. Conversely, a decrease in the LRAS curve, reflecting a contraction in the economy's productive capacity, will shift the vertical LRAS curve to the left, resulting in a higher price level and lower real GDP in the long run.
• Analyze the role of the LRAS curve in the AD-AS model's incorporation of economic growth, unemployment, and inflation.
  • The LRAS curve plays a crucial role in the AD-AS model's ability to incorporate economic growth, unemployment, and inflation. In the long run, the LRAS curve is vertical, indicating that the level of real GDP is determined by the economy's production capabilities, not the level of aggregate demand. This means that economic growth, which increases the economy's productive capacity, will shift the LRAS curve to the right, leading to higher real GDP and lower inflation in the long run. Similarly, the LRAS model assumes that the economy will always return to its full-employment level of output, meaning that any deviations from full employment, such as unemployment, will be temporary and corrected by market forces in the long run. The LRAS curve's vertical shape also implies that changes in aggregate demand will only affect the price level, not real GDP, in the long run, allowing the model to capture the relationship between inflation and the level of economic activity.

Related terms

Aggregate Demand: The total demand for all goods and services in an economy at a given price level and time.

Aggregate Supply: The total supply of all goods and services produced within an economy at a given price level and time.

Short-Run Aggregate Supply: The relationship between the price level and the quantity of real GDP supplied in the short run, when at least one input price is fixed.