LRAS and PPC

Introduction

Economic growth means the economy’s potential output is rising. Because the long-run aggregate supply (LRAS) curve is a vertical line at the economy’s potential, we can depict the process of economic growth as one in which the long-run aggregate supply curve shifts to the right.

As we have learned, there are two ways to model economic growth: (1) as an outward shift in an economy’s production possibilities curve, and (2) as a shift to the right in its long-run aggregate supply curve. In drawing either one at a point in time, we assume that the economy’s factors of production and its technology are unchanged. Changing these will shift both curves. Therefore, anything that increases the quantity or quality of factors of production or that improves the technology available to the economy contributes to economic growth.

Exploring the LRAS and PPC

The long-run aggregate supply (LRAS) curve is vertical at the full employment level of output. This means that LRAS doesn’t change as the price level changes. The location of the LRAS depends on the productive capacity of the economy. Developing more/better resources or improving technology will shift the LRAS curve outward.

The LRAS curve represents a point on an economy’s production possibilities curve (PPC).

Remember that the PPC represents the maximum output that can be produced given scarce resources.

The economy grows if the PPC shifts outward with more/better resources or if there are technological advances.

Aggregate output in the economy can actually be greater than LRAS in the short run. This means that resources are being used more intensively. For example, workers can work double hours in the short run. However, they can’t continue to work that number of hours in the long run. Eventually, the equilibrium level of output will always return to the full-employment level. Aggregate output can only increase in the long run if the LRAS has increased.

*Please make sure not to confuse real gross domestic product (GDP) changes in the short run due to business cycles with long-run economic growth.

Watch the presentation below to learn more.

So, Is LRAS Stuck Forever?

NO! Economic growth (producing more stuff) is possible. Watch the presentation below to learn more.

Review

Review what you have learned by completing the activity below.

In Summary . . .

The diagram here shows the long-run aggregate supply curve that was created by John Maynard Keynes. Keynes believed that the long-run aggregate supply curve (LRAS) has three main segments through which a market will go through over time. Keynes believed that at the beginning, the market will start out with an increased level of output with no increase in prices since there is lots of spare capacity in the economy. Once the market moves through the early parts of the LRAS, the spare capacity will then be used up and output will go up at the same time. Therefore, the costs of the factors of production will rise. After the middle section in the LRAS, employment will be full since output cannot be increased since all the factors of production are being utilized. Looking at the graph, think about the agricultural market in Florida (oranges!). Land used to be very cheap in Florida but as it has become more populated (retired people love the sun), the “spare capacity” has diminished and farm land has increased in price. However, agricultural advances continue as does output- so are we still on the curve?

IMAGES CREATED BY GAVS