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Long Run Aggregate Supply

Long Run Aggregate Supply

What determines the overall production of goods and services in the economy? How would an increase in immigration impact a country's long-run potential output? How has technology impacted the overall output produced in the U.S economy? You will be able to answer all these questions once you read our explanation in the Long-Run Aggregate Supply.

Long-Run Aggregate Supply Definition

The short-run aggregate supply curve depicts the number of goods and services produced in an economy at different price levels. This supply curve is only concerned with the number of goods and services produced during the short run. However, when we consider the long-run aggregate supply, we'd have to consider how production in an economy takes place during the long run. That is to say, we'd have to consider the factors that influence the production capacity of an economy in the long run.

In the long term, an economy's output of goods and services (its real GDP) relies on its supply of labor, capital, and natural resources and the available technologies utilized to transform these production elements into products and services. The reason for that is that the long-run aggregate supply assumes that the quantity of money does not impact technology or the quantity of labor, capital, and natural resources. That means that the price level and wages are flexible in the long run.

Long-run aggregate supply refers to the total amount of production in an economy given that its full resources are employed.

Long-term drivers of real GDP are unaffected by price levels; hence the aggregate supply curve is vertical, as seen in Figure 1. As the LRAS is vertical, there is no long-run trade-off between inflation and unemployment.

Long Run Aggregate Supply curve StudySmarter OriginalsFigure 1. Long-Run Aggregate Supply curve, StudySmarter Originals

The overall amount of products and services provided is determined by the economy's labor, capital, natural resources, and technology over the long term. This quantity supplied is constant regardless of price.

Classical Long-Run Aggregate Supply

Modern aggregate models follow concepts in classic macroeconomic theory; read this deep dive below for more info on why the long-run aggregate supply is vertical.

The vertical long-run aggregate supply curve is a graphical illustration of the classical dichotomy and monetary neutrality. Classical macroeconomic theory is founded on the premise that real variables do not rely on nominal variables. The long-run aggregate supply curve is compatible with this theory. It suggests that the amount of production (a real variable) does not rely on the level of prices (a nominal variable). The classical long-run aggregate supply is vertical, which does not change as the price level changes. The reason for that is that firms do not change their output in the long run, as resources adjust to the change in price.

Long-Run Aggregate Supply Curve

The long-run aggregate supply curve illustrates the relationship between the aggregate price level in the economy and the aggregate output supplied that would take place if prices and nominal wages were flexible.

Long Run Aggregate Supply StudySmarter OriginalsFigure 2. Long-Run Aggregate Supply, StudySmarter Originals

Figure 2 shows the long-run aggregate supply curve. Notice that the long-run aggregate supply is perfectly inelastic because it has no response to changes in price. That means that in the long run, regardless of the price level, the quantity of output would be fixed. The reason for that is that the price level does not impact the level of production in the economy in the long term.

Another important thing to consider is the long-run aggregate supply curve position along the horizontal axis. At the point where the LRAS intersects, the horizontal axis, which depicts the real GDP, provides the economy's potential output (Y1).

The LRAS curve is in line with the production possibilities curve (PPC), representing the maximum sustainable capacity. Maximum sustainable capacity refers to the total amount of production that can occur, given that all resources are fully employed.

The potential output is the real GDP that an economy would have if prices and wages were flexible. It is used to analyze economic fluctuations between potential output and real output. It is significantly hard to find periods in the economy where the actual output is the same as the potential output. You can usually find that the actual production is below or above the potential output. This helps economists analyze economic shocks that might have caused deviation from potential output. AD-AS model is one of the widely used models to analyze such fluctuations.

To learn more about the AD-AS model, check out our article.

Shifts in Long-Run Aggregate Supply

The long-run supply curve shows the number of products and services produced in the economy in the long term. The term "potential output" refers to the long-term level of production. The long-run aggregate supply curve can shift only when there are changes in factors that affect the potential output of an economy.

Factors that shift the long-run aggregate supply include labor, capital, natural resources, and technology changes.

Long Run Aggregate Supply Shifts in LRAS curve StudySmarter OriginalsFigure 3. Shifts in LRAS curve, StudySmarter Originals

Figure 3 shows shifts in the long-run aggregate supply curve. A rightward shift in the LRAS (from LRAS1 to LRAS2) will increase real GDP (from Y1 to Y3), and a leftward shift (from LRAS1 to LRAS2) will decrease real GDP (from Y1 to Y2). What might causes these shifts in the LRAS to occur? Read the determinants of long-run aggregate supply to find out.

Changes in labor

Consider a scenario in which an economy sees an increase in foreign workers. The number of products and services offered would rise due to increased employees. Consequently, the long-run aggregate supply curve would move to the right. Conversely, if enough employees left the economy to migrate overseas, the long-run aggregate-supply curve would shift to the left.

Also, the minimum wage has an impact on the long-run aggregate supply. That is because the potential output considers the natural unemployment rate. That means that the potential output considers all the workers employed at that level of economic production.

Suppose Congress were to increase the minimum wage considerably. In that case, fewer workers will be demanded as the cost of production rises, and the economy would generate a lower amount of products and services. A shift to the left in the long-term aggregate supply curve would follow due to this change.

Changes in capital

When an economy experiences a rise in its capital stock, this enhances productivity, and as a result, more products and services can be delivered. As more products and services could be produced, the potential output in the economy would rise as well. This would cause the long-run aggregate supply to shift to the right.

On the other hand, a drop in the economy's capital stock affects productivity and the number of goods and services provided, pushing the long-run aggregate- supply curve to the left. This results in lower potential output.

Changes in natural resources

The natural resources of a country directly impact the production of the economy. Countries with rich natural resources have greater productivity and can produce more output than other countries. Discovering new materials and using new natural resources shift the long-run aggregate supply of a country to the right.

On the other hand, depleting natural resources will result in lower potential output shifting the LRAS to the left.

Technological advancements

The advancement of technology is perhaps one of the most important factors influencing the long-run aggregate supply curve. Consider labor productivity before computers and after. The number of goods and services produced through computers while using the same labor has increased significantly.

When an economy experiences technological advancement, it will cause a rightward shift in the long-run aggregate supply. That is because it directly improves productivity allowing for more goods and services to be produced using the same labor and capital.

The aggregate supply curve would be shifted to the left in the long term if new restrictions were passed by the government prohibiting companies from employing certain manufacturing techniques due to worker safety or environmental concerns.

Long-run aggregate supply examples

Let's consider a country that sees an increase in foreign workers as an example of the long-run aggregate supply.

Before the migration of foreign workers, the economy was producing a certain amount of goods and services, and for this amount of goods and services, there was a certain number of workers being hired. What happens when more people start coming to the economy?

Firstly, the new foreign people will have a demand for goods and services to survive day-to-day activities. This means that more goods and services must be produced to meet the new demand coming from migration.Secondly, these people will have to work, which will increase the number of labor available in the economy. As the labor supply increases, the wages drop. A wage drop for firms means a drop in the cost of production.

Hence, the overall result will increase potential output (rightward shift in LRAS). This is because an increase in aggregate demand and labor supply allows supply and demand to increase in tandem, moving to a higher equilibrium.

Difference between short-run and long-run aggregate supply

The aggregate supply curve behaves quite differently in the short term than in the long term. The main difference between short-run and long-run aggregate supply is that short-run aggregate supply depends on the price level, whereas long-run aggregate supply does not depend on the price levels.

The long-term aggregate-supply curve is vertical because, in the long run, the general level of prices and wages does not impact the economy's capacity to generate goods and services as they are flexible. Prices have a short-term impact on economic activity, though. Over a year or two, a rise in the overall level of prices in the economy tends to raise the number of goods and services provided, while a fall in the level of prices tends to lower the number of goods and services supplied. Consequently, the short-run aggregate supply curve is upward sloping.

Long-Run Aggregate Supply (LRAS) - Key takeaways

  • The long-run aggregate supply curve is vertical because, in the long run, the general level of prices and wages does not impact the economy's capacity to generate goods and services as they are flexible.
  • As the LRAS is vertical, there is no long-run trade-off between inflation and unemployment.
  • The LRAS curve is in line with the production possibilities curve (PPC), representing the maximum sustainable capacity.
  • Maximum sustainable capacity refers to the total amount of production that can occur, given that all resources are fully employed.

Frequently Asked Questions about Long Run Aggregate Supply

Long run aggregate supply refers to the total amount of production that takes place in an economy given that its full resources are employed. 

Factors that shift the long-run aggregate supply include labor changes, capital changes, natural resources, and technology changes.

Long-run Aggregate supply curve is vertical because, in the long run, the general level of prices and wages does not impact the economy's capacity to generate goods and services as they are flexible. 

In the long term, an economy's output of goods and services (its real GDP) relies on its supply of labor, capital, and natural resources and the available technologies utilized to transform these production elements into products and services.

Final Long Run Aggregate Supply Quiz

Question

What is the long run aggregate supply?

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Answer

Long run aggregate supply refers to the total amount of production that takes place in an economy given that its full resources are employed. 

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Question

What causes the long run aggregate supply curve to shift?

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Answer

Factors that shift the long-run aggregate supply include labor changes, capital changes, natural resources, and technology changes.

Show question

Question

Why is aggregate supply vertical in the long run?

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Answer

Long-run Aggregate supply curve is vertical because, in the long run, the general level of prices and wages does not impact the economy's capacity to generate goods and services as they are flexible. 

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Question

What are the components of long run aggregate supply?


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Answer

In the long term, an economy's output of goods and services (its real GDP) relies on its supply of labor, capital, and natural resources and the available technologies utilized to transform these production elements into products and services.

Show question

Question

Briefly explain the classical LRAS. 

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Answer

The classical long-run aggregate supply is vertical, which means that it does not change as the price level changes. The reason for that is that in the long run, firms do not change their output, as resources adjust to the change in price.

Show question

Question

Is there a trade off between inflation and unemployment in the long run?

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Answer

As the LRAS is vertical it means that there is no long-run trade-off between inflation and unemployment. 

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Question

Why LRAS corresponds to PPC curve?

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Answer

The LRAS curve is in line with the production possibilities curve (PPC) as they both represent the maximum sustainable capacity.  

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Question

What is maximum sustainable capacity?  


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Answer

Maximum sustainable capacity refers to the total amount of production that can take place given that all resources are fully employed.

Show question

Question

Explain the difference between the short run and long run aggregate supply.

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Answer

The aggregate supply curve behaves quite differently in the short term than in the long term. The main difference between short-run and long-run aggregate supply is that short-run aggregate supply depends on the price level, whereas long-run aggregate supply does not depend on the price levels.


The long-term aggregate-supply curve is vertical because, in the long run, the general level of prices and wages does not impact the economy's capacity to generate goods and services as they are flexible. 

Show question

Question

Do prices impact the level of production in the long run?

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Answer

No.


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Question

What happens when the LRAS shifts to the right?

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Answer

The real GDP increases.

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Question

What happens when the LRAS shifts to the left?

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Answer

The real GDP decreases.

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Question

Explain how changes in labor affect the LRAS.

Show answer

Answer

Consider a scenario in which an economy sees an increase in foreign workers. The number of products and services offered would rise due to increased employees. Consequently, the long-run aggregate supply curve would move to the right. Conversely, if enough employees left the economy to migrate overseas, the long-run aggregate-supply curve would shift to the left.

Show question

Question

Explain how changes in capital affect the LRAS.

Show answer

Answer

When an economy experiences a rise in its capital stock, this enhances productivity, and as a result, more products and services can be delivered. As more products and services could be produced, the potential output in the economy would rise as well. This would cause the long-run aggregate supply to shift to the right.

On the other hand, a drop in the economy's capital stock affects productivity and the number of goods and services provided, pushing the long-run aggregate- supply curve to the left. This results in lower potential output.

Show question

Question

Explain how changes in natural resources affect the LRAS.

Show answer

Answer

The natural resources of a country directly impact the production of the economy. Countries that have rich natural resources have greater productivity and can produce more output than other countries. Discovering new materials and using new natural resources shift the long-run aggregate supply of a country to the right.

On the other hand, depleting natural resources will result in lower potential output shifting the LRAS to the left.

Show question

Question

Explain how changes technology affect the LRAS.

Show answer

Answer

The advancement of technology is perhaps one of the most important factors influencing the long-run aggregate supply curve. Consider the labor productivity before computers and after. The number of goods and services produced through computers while using the same amount of labor has increased significantly.

When an economy experiences technological advancement, it will cause the long-run aggregate supply. That is because it directly improves productivity allowing for more goods and services to be produced using the same labor and capital.

Show question

Question

In the long run, ____ and ____ are flexible.

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Answer

Wages

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Question

The LRAS curve is ______.

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Answer

Vertical

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Which of the following does NOT determine the LRAS curve.

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Answer

None of the above

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Question

The long-run aggregate supply curve illustrates the relationship between the aggregate ______ and aggregate ______ in the economy

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Answer

price level

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Question

Why is the LRAS curve perfectly inelastic?

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Answer

prices are flexible

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Question

The potential output is the real GDP that an economy would have if prices and wages were _____.


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Answer

flexible

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The long-run aggregate supply curve can shift only when...


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Answer

factors change that affect the output of an economy

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Question

What would happen to output if the LRAS curve shifted to the right?

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Answer

output would increase

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What would happen to output if the LRAS curve shifted to the left?

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Answer

output would decrease

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Question

True or False: The SRAS and LRAS curve have the same shape.

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Answer

False

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Question

Explain maximum sustainable capacity. 

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Answer

It refers to the total amount of production that can occur, given that all resources are fully employed.

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True or False: With the LRAS curve, there is no long-run trade-off between inflation and unemployment. 

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Answer

True

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True or False: a leftward shift of the LRAS curve means that the economy is shrinking.

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Answer

True

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True or False: a rightward shift of the LRAS curve means that the economy is growing.

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Answer

True

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Question

Explain why the LRAS curve is vertical.

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Answer

The level of prices and wages does not impact the economy's capacity to generate goods and services in the long run

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Question

What is the main difference between the SRAS and LRAS curves?

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Answer

The importance of price level. 

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Question

True or False: Technological advancements push the LRAS curve to the right.

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Answer

True

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True or False: Immigration (or an influx of population) pushes the LRAS curve to the right.

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Answer

True

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Question

True or False: there is no relationship between LRAS, SRAS, and AD curves.

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Answer

False

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