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aggregate supply

The Long Run Aggregate Supply (LRAS) is vertical at the potential GDP level, indicating that in the long run, changes in the price level do not affect real GDP. Short-term fluctuations can occur, leading to inflationary or recessionary gaps, but the economy will ultimately return to full employment. Classical economists argue LRAS can increase over time, while Keynesian economists suggest intervention may be necessary due to the slow adjustment of wages and prices.

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4 views3 pages

aggregate supply

The Long Run Aggregate Supply (LRAS) is vertical at the potential GDP level, indicating that in the long run, changes in the price level do not affect real GDP. Short-term fluctuations can occur, leading to inflationary or recessionary gaps, but the economy will ultimately return to full employment. Classical economists argue LRAS can increase over time, while Keynesian economists suggest intervention may be necessary due to the slow adjustment of wages and prices.

Uploaded by

naomip07822
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Long run aggregate supply - LRAS

Relationship between the price level and output in the flexible wage and
resource period, where wages, prices and resources can adjust to the level
of demand

Downwardly inflexible nature of wages and prices – employers are


relatively unwilling to reduce wages and prices. (sticky wages)

One of the main arguments for this view is that prices are flexible. If there
is excess supply of labour, workers will reduce their wage demands,
causing employers to want to hire more about and workers to offer less
labour for sale until the surplus is eliminated.

One response to the neoclassical argument is that the prices are not
perfectly flexible

Firms and workers way be reluctant to lower prices/ wages

Workers contracts take time to be changed

Neo-classical

 LRAS is located at potential GDP


 It is vertical at this point
 It represents the level of full employment or GDP
 In the long run a change is price level does not result in change of
quantity or real GDP
 Potential GDP>LRAS is assumed to be independent of the price level
 In the long run, the ability of an economy to produce goods and
services to meet demand is based on the overall state of technology
and availability and quality of factor inputs economy is self-
correcting

Short run

Inflationary gap is between Yp and Y2 on the short run

AD shift to the right

Increase in AD encourages firm to expand output and probably prices

Knock on effects to factor markets: CELL – factors of production

Leads to higher input costs

Long run

The higher costs cause an upward shift in SRAS


takes national output back towards the original level of output eg back
towards the long run equilibrium for the economy found at Yp.
A recession in SR then LR

In the long run the fall in the price level in matched by a fall in the wages
and other resource prices

LRAS assumptions

Means that there cannot be inflationary or recessionary gaps in the long


run

Gaps only occurs in the short run

So, there may be short term fluctuations in output but the economy will
always return to the full employment level of GDP in the long run

Summary:

1. LRAS is vertical at full employment level of GDP


2. In LR economy produced potential GDP
3. Economy always returns to full employment level despite shirt run
fluctuations
4. Recessionary and inflationary gaps are eliminated in the long run
5. Increases in AD in the LR are inflationary only – no change in real
output

Classical economist believe that the long run aggregate supply can
increase in the long run

Keynesian economists believe the economy might need help to recover e\


becuase wages and prices don’t adjust quickly

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