MODULE 18
LONG-RUN AGGREGATE
SUPPLY
By J.A.Sacco
Aggregate Supply
• Knowing the position and shape of AD does not tell us
anything about how the total dollar value of spending will
be divided between output (real goods/services) and
prices.
• To determine this and thus the equilibrium level of real
GDP must also look at aggregate supply.
• Aggregate Supply- shows the relationship between
planned rates of total production for the entire economy at
various prices
Two Types of Aggregate Supply Curves
LRAS- Long Run
SRAS- Short Run
An Old Friend Revisited
• What does the PPC
have in common with
the LRAS?
The PPC and the Long-Run Aggregate Supply Curve
LRAS 1
Price Level
Capital Goods
Over time, the
production
possibilities curve
shifts outward.
Consumption Goods
LRAS 2
This same principle
can be shown by
shifting the LRAS
curve to the right.
0
1
2
3
4 5 6 7 8
Real GDP per Year
($ trillions)
9
10
The Long Run Aggregate Supply Curve
• A vertical line representing
real output of goods and
services based on full
information and after full
adjustments has occurred
• Represents the real output
of the economy under
conditions of full
employment
• Shows the potential level
of output when resources
are fully employed
LRAS is vertical
because all
resources fully
employed, output
can not be increased
at present time
Nothing changes ! What doesn’t change that makes the LRAS vertical?
Why the LRAS is Vertical
Key is Inputs do not change!!!
• Technology does not Change- No change in technology,
no change in output.
Why the LRAS is Vertical
• Endowments of Resources Fixed- Amount/Quality of
resources does not change. If these resources were being
fully used then output will be maximum in the long run.
Why the LRAS is Vertical
• Labor Productivity- No change in productivity means no
change in output
Why the LRAS is Vertical
• Population is Constant- No growth in population means
no increase in the labor force/ no change in output.
Why the LRAS is Vertical
• Full Adjustment to Price Level Changes- The price level has no
effect on real GDP. If the price level for GDP rises, there will be
comparable rise in input prices. Therefore suppliers have no
incentive to increase output.
Cost of Inputs = Money received from Output
There is no profit . No incentive to produce anymore.
Input prices and output receipts all part of the
same price level. An implication of all of this is that
aggregate demand has no effect on LRAS and output.
LRAS- Review
• Therefore the LRAS illustrates full information and full
adjustment level of real output (inflation adjusted) of
goods/services.
• The LRAS is the level of real output that will continue
being produced year after year, forever, if nothing
changes.
• Full employment level of real GDP. When economy
reaches full employment, no further adjustments will occur
unless a fundamental change occurs
Shifts in the LRAS
• The LRAS shifts outward
when one of the non-price
level determinants change
in the following way
1. Population increase
2. Resources increase
3. Technology improves
Permanent Changes!
Aggregate Demand and
Long-Run Aggregate Supply
• Because the LRAS is vertical, AD in the long run has no
bearing on the level of output of real goods and services
• If there is a shift of AD in the long run, the only thing that
level (inflation). ?
changes is the price
___________
Shift of AD in long run only leads to inflation!!!
Aggregate Demand and
Long-Run Aggregate Supply
GDP Deflator
LRAS
Changes in AD
have no impact
on LRAS--only
on the price level
120
90
AD2
AD1
0
1
2
3
4
5
Real GDP per Year
($ trillions)
6
7
Aggregate Demand and
Long-Run Aggregate Supply
• In the long run, output
of real goods/services
is supply-side
determined. Only
shifts in LRAS will
change long run levels
of output not a shift of
AD.