Long-run aggregate supply

Definition

Long-run aggregate supply (LRAS) represents the total output of goods and services that an economy can produce when operating at full capacity, factoring in all available resources and technology. This curve is vertical, indicating that in the long run, the economy's output is determined by factors such as labor, capital, and technology rather than the price level. LRAS signifies the economy's potential GDP, which remains unchanged by price level fluctuations over time.

5 Must Know Facts For Your Next Test

1. The long-run aggregate supply curve is vertical because it reflects the economy's capacity to produce goods and services regardless of the price level.
2. Changes in resources, technology, and institutions can shift the LRAS curve to the right or left, indicating growth or contraction in potential output.
3. In the long run, the economy returns to its potential GDP after short-run fluctuations caused by demand shocks or supply shocks.
4. Factors such as population growth, investment in capital goods, and improvements in technology directly impact the LRAS by increasing the economy's productive capacity.
5. When aggregate demand exceeds long-run aggregate supply, it can lead to inflationary pressures, as the economy cannot sustain production levels above potential GDP.

Review Questions

• How does long-run aggregate supply differ from short-run aggregate supply in terms of price level sensitivity?
  • Long-run aggregate supply is vertical and indicates that the total output is not affected by changes in the price level; rather, it depends on resource availability and technology. In contrast, short-run aggregate supply can be upward sloping since firms may respond to higher prices by increasing production temporarily. This difference highlights how economic output can be influenced by price changes in the short run but stabilizes at potential output in the long run.
• Discuss how changes in technology impact the long-run aggregate supply curve.
  • Improvements in technology enhance productivity and efficiency within an economy, allowing for greater output with the same level of inputs. As technology advances, it shifts the long-run aggregate supply curve to the right, indicating an increase in potential GDP. This shift signifies that the economy can produce more goods and services sustainably without inflationary pressures, thus supporting long-term economic growth.
• Evaluate the implications of a rightward shift in the long-run aggregate supply curve for overall economic performance.
  • A rightward shift in the long-run aggregate supply curve suggests an increase in an economy's productive capacity, which can lead to higher potential GDP. This growth results from factors such as improved technology, increased labor force participation, or greater capital investment. Consequently, this shift can enhance overall economic performance by promoting higher levels of employment and sustainable growth while mitigating inflationary pressures since the economy can meet rising aggregate demand without exceeding its potential output.

Related terms

Short-run aggregate supply: Short-run aggregate supply (SRAS) reflects the total production of goods and services in an economy when some input prices are fixed, allowing for adjustments to the output level as prices change.

Potential GDP: Potential GDP is the maximum level of output that an economy can achieve when utilizing its resources efficiently and sustainably, consistent with its long-term growth trends.

Full employment: Full employment refers to a situation in which all available labor resources are being used in the most efficient way possible, resulting in an unemployment rate that only includes frictional and structural unemployment.