UNIT 3 Macroeconomics LESSON 7 The Long-Run Economy Introduction and Description The last lesson explored the movement of the economy from the short run to the long run. Here, we explore the long-run aggregate supply curve and its relationship with the economy’s production possibilities curve, introduced in Unit 1. Activity 29 draws together the relationship between the long-run aggregate supply curve and the production possibilities curve studied earlier. Objectives 1. Review the process of moving from the short run to the long run. 2. Review the factors that shift the long-run aggregate supply curve. 3. Relate the long-run aggregate supply curve to the production possibilities curve. Time Required One class period or 45 minutes Materials 1. Activity 29 2. Visual 3.14 Procedure 1. Review the process discussed in the last lesson of moving from the short run to the long run. 2. Explain that normally the economy will adjust and return to the original LRAS curve. However, if there is an adverse supply shock that results in a permanent decrease in resources, the LRAS curve could shift to the left. There is evidence that the OPEC oil price increases had exactly this impact in the 1970s. 3. Discuss the factors that will shift the LRAS curve to the right. These factors are increases in productivity of labor, increases in technology and increases in the capital stock. Discuss factors that might influence the productivity of labor (education), increases in technology (research and development expenditures) and increases in the capital stock of the economy (low, stable interest rates). 4. Project Visual 3.14. Demonstrate that increases in the factors that shift the LRAS curve will also shift the production possibilities curve for the economy. Factors that shift the LRAS curve to the right shift the production possibilities curve outward or to the right. Factors that shift the LRAS curve to the left shift the production possibilities curve inward or to the left. 5. Have the students complete Activity 29. Review the answers with the students. Advanced Placement Economics Teacher Resource Manual © National Council on Economic Education, New York, N.Y. 497 UNIT 3 Macroeconomics LESSON 7 ■ ACTIVITY 29 Answer Key Long-Run Aggregate Supply (LRAS) and the Production Possibilities Curve (PPC) The long-run aggregate supply (LRAS) curve differs from the short-run aggregate supply (SRAS) curve. The LRAS curve is a vertical line at an output level that represents the quantity of goods and services a nation can produce over a sustained period using all of its productive resources as efficiently as possible with all of the current technology available to it. Long-run aggregate supply is at full employment. LRAS doesn’t change as the price level changes. Developing more and better resources or improving technology will shift the LRAS curve outward, but it will still be vertical. The LRAS curve represents a point on an economy’s production possibilities curve. Remember that the production possibilities curve (PPC) represents the maximum output of two goods that can be produced given scarce resources. The economy could grow if the PPC shifts outward because of more resources or technological advances. For the same reason, the LRAS curve shifts outward if more resources are developed or if there are technological advances. SRAS can actually be greater than LRAS. Resources can be used more intensively in the short run. For example, workers can work more hours and machines can operate for more hours. However, this output level cannot be sustained in the long run. Eventually, the equilibrium level of output will fall unless LRAS is increased. As an analogy on a personal level, you may pull an all-nighter to prepare for several exams on the same day. You cannot, however, work 24 hours a day all the time. 498 Advanced Placement Economics Teacher Resource Manual © National Council on Economic Education, New York, N.Y. UNIT 3 Macroeconomics LESSON 7 ■ ACTIVITY 29 Answer Key Now answer the questions that follow to be sure you understand these concepts. Use the graphs in Figure 29.1 in your answers. Figure 29.1 Aggregate Supply and Production Possibilities Curves PPC Graph LRAS SRAS Y* Y1 REAL GDP Y2 CAPITAL GOODS PRICE LEVEL LRAS and SRAS Curves B A C CONSUMER GOODS 1. What information does a PPC provide for us about a nation’s economy? The maximum possible combinations of two types of goods an economy can produce when the economy is fully employing all its resources in a given time period and with a given technology 2. What assumptions do you make about the use of available resources when drawing a PPC? When we are on a PPC, resources are fully employed and are being used in the most efficient way given the current state of technology. 3. What would cause a nation’s PPC to shift? Changes in the amount of resources or changes in technology 4. What do you know about a nation’s economy that is operating on the LRAS curve? The economy is fully employing its resources in the most efficient way given the current state of technology. It can’t produce more of one good without producing less of another. 5. Under what conditions would an economy be on the LRAS curve? It would be fully employing all of its resources and be on its PPC. Advanced Placement Economics Teacher Resource Manual © National Council on Economic Education, New York, N.Y. 499 UNIT 3 Macroeconomics 6. If the price level rises, will LRAS shift? No LESSON 7 ■ ACTIVITY 29 Will the LRAS curve shift if AD changes? Answer Key No 7. If an economy finds that it faces a short-run equilibrium where real GDP is Y1, how would you describe the condition of the economy? Given this equilibrium level of output, at what point would the economy lie on the PPC? Explain your answer. Resources are unemployed. The economy is inside the PPC at a point like C. The economy can produce more consumer goods and more capital goods if all resources are fully employed. 8. If an economy finds that it faces a short-run equilibrium where real GDP is Y*, how would you describe the condition of the economy? Given this equilibrium level of output, at what point would the economy lie on the PPC? Explain your answer. The economy would be operating on the PPC at Point B. All resources are fully employed. 9. If an economy finds that it faces a short-run equilibrium where real GDP is Y2, how would you describe the condition of the economy? Given this equilibrium level of output, at what point would the economy lie on the PPC? Explain your answer. The condition of the economy is overheated and at Point A outside the PPC. The economy is working beyond the full-employment level of production and will not be able to sustain this level unless the LRAS increases, or shifts to the right. 10. If the economy were producing at Y2, what would happen in the long run? Why? Eventually output will decrease. People and production facilities can work overtime without maintenance problems in the short run only. Eventually, the price level and nominal wages will increase. 11. What could cause a nation’s LRAS to shift? The development of more productive resources or an improvement in technology will cause LRAS to shift to the right. The capital stock increases. 12. How would a rightward shift in LRAS be shown on the PPC? The PPC would shift outward also. 500 Advanced Placement Economics Teacher Resource Manual © National Council on Economic Education, New York, N.Y.
