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Macroeconomics: aggregate supply-long-run analysis-

  • Long-run aggregate supply (LRAS) refers to the level of output of a nation's producers in response to a change in the price level in a period of time over which wages  and other costs of production are flexible.
  • In the long-run, workers will demand higher wages caused by an increase in aggregate demand and inflation, or will take lower wages in response to a decrease in aggregate demand, deflation, and rising unemployment.
  • In the long-run, output will return to its full-employment level as the costs of production adjust to the level of demand in the economy.
    • The LRAS curve is vertical and intersects the AD curve at its full employment level (NRU).
    • This reflects the idea that labor market has settled into equilibrium, there is a quantity of goods produced in the economy, that is independent of the price level.
    • Any change in the AD will not effect the national output, it will only effect the level of inflation/ deflation.
  • A fall in AD is caused by a decrease in the following variables C,I,G,or Xn. In the long run, a fall in AD only causes deflation, it does not affect GDP or employment level. Response to the falling AD, firms lower the wages of their workers and reduce the price of their goods.
  • A rise in AD causes inflation but does not affect the level of production or the level of employment in the economy. In response to the rising demand for the goods and services, firms need to increase the wage rate in order to attract new workers and increase production.
  • The LRAS curve can shift to the right if there is an increase in capital (I), population growth, a drop in the NRU level, or a change in technology. Keep in mind that if there is less capital, a smaller population, or an increase in the NRU, the LRAS can shift to the left.
Reference: Welker, Jason. AP Maroeconomics Crash Course. Research & Education Association (2014). p 127-129.
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