Skip to main content

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.

Comments

Popular posts from this blog

Macroeconomics: multiplier and crowding out effects

Multiplier effect: whenever   any of the components of AD increases, the increase in GDP will be greater than the initial increase in expenditures. The impact on GDP of a particular increase in spending depends on the proportion of the new income that is taken out of the system to the proportion that continues to circulate in the economy. The multiplier effect tells us the impact a particular change in one the components of AD will have on the total income (GDP).  Let k denote the spending multiplier, which is a function of MPC and MPS. The larger the marginal propensity to consume, the larger the spending multiplier. Notice that the larger the MPC, the greater the impact a particular change in the spending variables will have on the nation's GDP. The crowding out effect: If government spending increases without an increase in taxes, the government must borrow funds from the private sector to finance its deficit, thereby increasing the interest rate. This increase in interest ...

Exercise: inflation and GDP deflator

You have the following table containing information about country Y's GDP deflator, nominal, and real GDP. If the base year is 2015, fill in the blanks and then find the annual inflation rate for each year. Year  Nominal GDP  GDP Deflator  Real GDP 2015 $23,457 100 $23,457 2016 $25,752 ... $23,943 2017 $25,982 108.1 ... 2018 $26,016 ... $25,431.1 2019 $26,323 105.5 ... Solution: Year  Nominal GDP  GDP Deflator  Real GDP   Inflation rate 2015 $23,457 100 $23,457 n.a 2016 $25,752 107.6 $23,943 7.6% 2017 $25,982 108.1 $24,035.2 0.45% 2018 $26,016 102.3 $25,431.1 -5.37% 2019 $26,323 105.5 $24,950.6 3.13%  GDP deflator for the year 2018: Real GDP for the year 2017: General formula to find real GDP by re-arranging the GDP deflator formula: Notice that the sub-index i is for the year. The (annual) inflation rate is simply the growth rate of prices from a year to its previous year: Inflation rate of the year 2018: Notice that in 2018 country Y experienced...

Exercise: Payoff matrix -Oligopoly market-

You are given a payoff matrix for two firms in an oligopoly market. Find the dominant strategy (if any) for each firm. What profit would they each earn if they form a cartel (if possible)? Can the cartel hold in the long run? If not, what is the long run equilibrium? Payoff Matrix:  Firm A: high prices  Firm A: low prices Firm B: high prices A: $1000 B: $1000 A: $1200 B: $800 Firm B: low prices A: $600 B: $1200 A: $700 B: $700 The dominant strategy for firm A is to charge a low price for its product. You can see that no matter what firm B chooses, firm A is always better off by choosing the low price option (i.e its profit is always bigger than if it had charged a high price). The strategy for firm B depends on the choices firm A makes. If firm A charges a high (low) price then firm B should charge a low (high) price. In order to find the point at which the firms would collude (i.e act as one monopolistic firm), find the point(s) where the sum of economic profits is the greate...