ASAD - Long Run Aggregate Supply (Lesson)

Long Run Aggregate Supply

Introduction

The short-run aggregate supply (SRAS) curve is upward sloping because of slow wage and price adjustments in the economy. But in the long run, wages and prices have time to adjust. That is, wages and prices are fully flexible. This means that any time the price level changes (i.e., there is inflation or deflation), wages and other input costs fully adjust so there are no overall effects. For example, if prices were doubled and wages and other input costs doubled, there would be no effect. Or if prices were cut in half, but so were wages and other input costs, there would be no effect. In the long run, wages and other input costs adjust so the economy always returns to the full-employment level of output. This means that the long-run aggregate supply (LRAS) curve is vertical at the full-employment output level (which is also called potential output).

 

Long Run Aggregate Supply (LRAS)

The keystone concept of macroeconomics is the aggregation. In this sense, aggregate supply (AS) is the total of all goods supplied by the entire economy (of a nation, for example); it is not limited to any one industry. Likewise, aggregate demand (AD) is the total of all goods demanded by the entire economy; it too is not limited to any one industry. Oftentimes, the goods produced by one industry will become the goods demanded by another.

Long run aggregate supply (LRAS) - Over the long run, only capital, labor, natural resources and technology affect the LRAS in the macroeconomic model because at this point everything in the economy is assumed to be used optimally. In most situations, the LRAS is viewed as static because it shifts the slowest of the three. The LRAS is shown as perfectly vertical, reflecting economists' belief that changes in aggregate demand (AD) have an only temporary change on the economy's total output.

Watch the video below to begin your study of the long run aggregate supply.

 

 

What determines the LRAS?

In the long-run the aggregate supply curve is perfectly vertical, reflecting economists' belief that changes in aggregate demand only cause a temporary change in an economy's total output. The long-run aggregate supply curve can be shifted, when the factors of production change in quantity.

 

 

Watch the presentation below to learn more.

 

Review

Review what you have learned by completing the activity below.

 

In Summary . . .

Imagine that economists expect the labor market to tighten, causing workers' wages to increase. Assuming this is the only development in the labor market, how would it affect the SRAS curve? What if it were also accompanied by an increase in worker productivity?

If new government regulations require firms to use a cleaner technology that is also less efficient than what was previously used, what would the effect be on output, the price level, and employment based on the AD/AS diagram?

During the spring of 2016, the Midwestern United States, which has a large agricultural base, experienced above-average rainfall. Using the AD/AS diagram, what is the effect on output, price level, and employment?

Hydraulic fracturing—fracking—has the potential to significantly increase the amount of natural gas produced in the United States. If a large percentage of factories and utility companies use natural gas, what will happen to output, the price level, and employment as fracking becomes more widely used?

Some politicians have suggested tying the minimum wage to the consumer price index. Using the AD/AS diagram, determine what effects this policy would most likely have on output, the price level, and employment.

 

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