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Long-Run Aggregate
Supply (LRAS)

Understand why the LRAS curve is vertical, what determines an economy's potential output, and how shifts in LRAS drive long-run economic growth.

AP Macroeconomics

What Is Aggregate Supply?

Aggregate supply represents the total quantity of goods and services that all producers in an economy are willing and able to supply at each price level. Economists distinguish between two time horizons:

Short Run (SRAS)
Some input prices (especially wages) are sticky: they adjust slowly. The SRAS curve slopes upward.
Long Run (LRAS)
All input prices fully adjust. Output depends only on an economy's productive capacity, not the price level.

Potential Output: \( Y_f \)

Potential output (also called full-employment output, \( Y_f \)) is the level of real GDP an economy produces when all resources are fully employed: labor is at its natural rate, capital is utilized normally, and technology is applied efficiently.

Why the LRAS Is Vertical

Real GDP Price Level LRAS \( Y_f \) \( P_2 \) \( P_1 \) Same \( Y_f \) at every price

The Classical Dichotomy

The vertical LRAS embodies the classical dichotomy: in the long run, real variables (output, employment) are independent of nominal variables (price level, money supply).

1
Money is neutral in the long run: doubling the money supply doubles prices but does not change real GDP.
2
Real GDP depends on factors of production: land, labor, capital, and technology.
3
Price level changes only affect nominal values, not the quantity of goods produced.

What Determines the Position of LRAS?

Since LRAS equals \( Y_f \), anything that changes the economy's productive capacity shifts the LRAS curve. Four categories matter:

Labor
Size and quality of the workforce: immigration, education, population growth
Capital
Physical capital (factories, equipment) and human capital (skills, training)
Technology
Innovations that raise productivity per unit of input
Institutions
Property rights, rule of law, trade policy, regulations

Shifting LRAS Right: Economic Growth

Real GDP Price Level LRAS₁ \( Y_{f1} \) LRAS₂ \( Y_{f2} \) Growth

Shifting LRAS Left: Capacity Decline

Events that reduce the economy's productive capacity shift LRAS to the left, lowering \( Y_f \):

1
Natural disaster destroys capital stock (factories, infrastructure).
2
Emigration or a shrinking labor force reduces the number of workers.
3
Institutional breakdown: war, corruption, or loss of property rights discourages investment.
4
Resource depletion permanently reduces a key natural resource.

LRAS vs SRAS: Key Distinction

LRAS SRAS
Shape Vertical Upward-sloping
Time Horizon Long run (all prices adjust) Short run (sticky wages/prices)
Output Level \( Y_f \) (potential) Can differ from \( Y_f \)
Shifted By Changes in productive capacity Input prices, supply shocks
Price Level Effect None on output Higher \( P \) → more output

The Full AD-AS Model

Real GDP Price Level LRAS SRAS AD Long-run EQ \( Y_f \) \( P_e \)

How to Analyze LRAS Shifts

1
Identify the event. Does it change the economy's productive capacity: labor, capital, technology, or institutions?
2
Determine the direction. Increase in capacity → LRAS shifts right. Decrease → LRAS shifts left.
3
Draw the new LRAS. Label the new \( Y_f \). Note: the price level is not directly affected by LRAS shifts alone.
4
Find the new long-run equilibrium. SRAS will eventually adjust so that AD, SRAS, and the new LRAS intersect.

Example 1: Technology Boom

Scenario: A major technological innovation increases labor productivity across all sectors of the economy.

Real GDP Price Level LRAS₁ LRAS₂ \( Y_{f1} \) \( Y_{f2} \)

Example 2: Immigration Surge

Scenario: A country experiences a large wave of immigration, significantly increasing the size of its labor force.

1
Identify: Immigration increases the quantity of labor, a factor of production.
2
Direction: More labor → higher productive capacity → LRAS shifts right.
3
Result: \( Y_f \) increases. The economy can sustain a higher level of real GDP at full employment.

Example 3: Does a Tax Cut Shift LRAS?

Scenario: The government cuts income taxes. Does this affect LRAS?

Demand-Side View
Tax cuts increase disposable income → consumers spend more → AD shifts right. This does not shift LRAS.
Supply-Side View
If the tax cut incentivizes more work, savings, or investment, it could increase productive capacity and shift LRAS right.

Self-Correction to LRAS

Real GDP Price Level LRAS SRAS₁ SRAS₂ AD SR EQ LR EQ \( Y_f \)

Common Mistakes

✕ Thinking LRAS Slopes Upward
The LRAS is always vertical. An upward slope is the SRAS. In the long run, output does not respond to price level changes.
✕ Confusing AD Shifts with LRAS
Changes in consumer spending, taxes, or money supply shift AD, not LRAS. LRAS shifts only from changes in productive capacity.
✕ Forgetting Self-Correction
Without government intervention, the economy returns to \( Y_f \) through wage/price adjustment. Don't assume gaps are permanent.

LRAS Summary

Feature Detail
Shape Vertical at \( Y_f \)
Why Vertical All prices and wages fully adjust
Determined By Labor, capital, technology, institutions
Shifts Right When Productive capacity increases (growth)
Shifts Left When Productive capacity decreases
Not Shifted By Price level, AD changes, money supply
Self-Correction SRAS adjusts until GDP = \( Y_f \)

Question 1 of 5

The long-run aggregate supply (LRAS) curve is vertical because:

Question 2 of 5

Which of the following would shift the LRAS curve to the right?

Question 3 of 5

If the economy is producing above \( Y_f \) (inflationary gap), the long-run self-correction mechanism involves:

Question 4 of 5

A devastating earthquake destroys a significant portion of a country's factories and infrastructure. What is the effect on the LRAS?

Question 5 of 5

At long-run macroeconomic equilibrium, which of the following must be true?