Long-run Aggregate Supply (LRAS)

Definition

The long-run aggregate supply (LRAS) curve represents the relationship between the price level and the quantity of real output supplied in the long run. It reflects the economy's productive capacity, which is determined by factors such as the available technology, capital stock, and labor force.

5 Must Know Facts For Your Next Test

1. The LRAS curve is vertical, indicating that the quantity of output supplied is independent of the price level in the long run.
2. The position of the LRAS curve is determined by the economy's productive capacity, which is influenced by factors such as technology, capital stock, and the labor force.
3. Increases in the economy's productive capacity, such as through technological advancements or growth in the labor force, shift the LRAS curve to the right, indicating a higher level of potential output.
4. The LRAS curve intersects the vertical axis at the economy's potential GDP, which represents the maximum sustainable level of output that can be produced without causing inflation.
5. In the long run, the economy will tend to gravitate towards the potential GDP level, as prices and wages adjust to eliminate any gaps between actual and potential output.

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 reflects the relationship between the price level and the quantity of output supplied in the short run, where at least one factor of production is fixed. In contrast, the LRAS curve represents the economy's productive capacity in the long run, where all factors of production can be adjusted. The LRAS curve is vertical, indicating that the quantity of output supplied is independent of the price level, as the economy moves towards its potential GDP level. This is in contrast to the upward-sloping SRAS curve, which reflects the short-run trade-off between the price level and the quantity of output supplied.
• Describe how changes in the economy's productive capacity affect the position of the LRAS curve.
  • The position of the LRAS curve is determined by the economy's productive capacity, which is influenced by factors such as technology, capital stock, and the labor force. Increases in the economy's productive capacity, such as through technological advancements or growth in the labor force, shift the LRAS curve to the right, indicating a higher level of potential output. Conversely, a decrease in the economy's productive capacity, due to factors like a decline in the labor force or a deterioration of the capital stock, would shift the LRAS curve to the left, reducing the economy's potential GDP. These shifts in the LRAS curve reflect the long-run changes in the economy's ability to produce goods and services, which is a key determinant of the sustainable level of output and employment.
• Explain the relationship between the LRAS curve and the concept of potential GDP, and how this relationship is important for understanding macroeconomic stability.
  • The LRAS curve is closely linked to the concept of potential GDP, which represents the maximum sustainable level of output that an economy can produce without creating inflationary pressures. The LRAS curve intersects the vertical axis at the economy's potential GDP level, indicating that in the long run, the economy will tend to gravitate towards this level of output. This relationship is important for understanding macroeconomic stability because it suggests that, in the long run, the economy will naturally move towards its productive capacity, with any deviations from potential GDP being temporary. If the economy is operating below its potential, there is room for growth without generating inflation. Conversely, if the economy is operating above its potential, inflationary pressures will emerge, and the economy will need to adjust back towards the LRAS curve and potential GDP. Understanding the LRAS-potential GDP relationship is crucial for policymakers in formulating effective macroeconomic policies to promote sustainable economic growth and stability.

Related terms

Aggregate Supply (AS): Aggregate supply is the total quantity of goods and services that firms are willing to sell at different price levels in an economy.

Short-run Aggregate Supply (SRAS):

The short-run aggregate supply curve shows the relationship between the price level and the quantity of output supplied in the short run, where at least one factor of production is fixed.

Potential GDP:

Potential GDP is the level of real GDP that an economy can produce when it is using all of its available resources efficiently, without creating inflationary pressures.