The long-run aggregate supply curve is a vertical line showing the economy’s potential level of real output when its labor, capital, technology, and other productive resources are fully utilized at sustainable levels. In the long run, the real output of goods and services is determined primarily by the economy’s productive capacity rather than by the price level. Understanding this curve is essential for interpreting inflation, recession, economic growth, and the long-term effects of government policy.
Meaning of the Long-Run Aggregate Supply Curve
The long-run aggregate supply curve, commonly abbreviated as LRAS, represents the relationship between the price level and the real gross domestic product that an economy can produce in the long run.
The curve is drawn vertically at the level of potential output, also called potential GDP or full-employment output. Potential output is not a guarantee that every person will find a job or that every available resource will be used perfectly. It is the level of production the economy can sustain when resources are employed at their normal or efficient rates Worth keeping that in mind..
At potential output:
- Cyclical unemployment is generally eliminated.
- The economy operates near its natural rate of unemployment, which includes frictional and structural unemployment.
- Firms produce at a sustainable rate relative to available labor, capital, and technology.
- Price changes alone do not create a lasting increase or decrease in real production.
The vertical shape means that the economy produces the same amount of real output at every price level in the long run. Here's one way to look at it: a 5 percent price level and a 10 percent price level could each be associated with the same potential GDP, provided the economy’s productive capacity has not changed.
Why the Long-Run Aggregate Supply Curve Is Vertical
The vertical shape of the LRAS curve rests on the classical distinction between nominal variables and real variables Small thing, real impact..
Nominal variables include the price level, the money supply, and nominal wages. Real variables include real output, real wages, employment, and the quantity of goods and services produced. Over the long run, changes in the money supply mainly affect nominal variables. They may raise or lower the price level, but they do not permanently change how many goods and services an economy can produce.
Suppose the central bank increases the money supply. In the short run, lower
