9.3 Long-Run aggregate supply

Factors that change aggregate supply over the long term

- increases in quantities of the factors of production - improvements in the quality of factors of production. - improvements in technology - increases in efficiency - institutional changes - efficiency in resources use, because changes in institutions can have on effect on how efficiently scare resources are being used. - reduction in the natural rate of unemployment.

Why is the the LRAS curve vertical?

- wages and resource prices are not flexible to match output prices, firms costs of production remain constant as the price level changes. - with constant real costs, firms' profits are also constant and firms no longer have any incentive to increase or decrease their output levels.

Monetarist/new classical economists principles

-importance of the price mechanism in coordinating economic activities - concept of competitive market equilibrium - thinking about the economy as a harmonious system that automatically tends towards full employment.

Key features of keynesian model

an economy can remain for long periods of time in an equilibrium where there is less than full employment. caused by insufficient AD:

Spare capacity

Physical capital (machines, equipment) that firms have available for use.

increases in AD need not cause an increase in price level (keynesian model)

because in horizontal part of the model (section I) because of spare capacity that can be used by firms to increase output without the change in price of wages and price of resources.

Why the long run AD only influences the price level

changes in aggregate demand in the monetarist model, can influence real GDP only in the short run, in the long, the only impact of a change in AD is to change the economy's price level. increases in AD in the long run are therefor inflationary.

Why is the LRAS curve situated at the level of potential GDP

inflationary gaps and recessionary gaps cannot persist in the long run. - are a short run phenomena - a fall in price level in the long run is matched with a fall in wages/resource prices in the long run . so the SRAS curve shifts to the right. the assumption of wage flexibility in the long run has allowed the economy to automatically come back to its long run equilibrium level of output. when AD increases in the short run, Real GDP increases, there is an inflationary gap. once wages increase to match the increase in the price level, SRAS shifts to the left, and the economy return to the LRAS (at a higher price level)

Long term growth versus short-term economic fluctuations

long term growth in the business cycle diagram, shows an increase in potential output corresponds to rightward shifting LRAS or Keynesian AS curved.

Vertical shape of the LRAS curve

means that in the long run a change in the price level does not result in any change in the quantity of real GDP produced.

LRAS curve

monetarist model, veritcal at full employment or real GDP.

Shifting aggregate supply curves over the long term

over time, LRAS and keynesian AS curve can shift to the right or left. each curve represents a particular level of potential output, the total quantity of goods and services produced by an economy when there is full employment of resources. an increase in potential output means economic gorwht over the long term.

Wage and price downwards inflexibility

what if resource prices cannot fall. keynesians argue that there is an asymmetry between wage changes in the upwards and downward direction. in a recessionary gap, wages do not fall easily because of: labour contracts, min wage legislation, worker and union resistance. Also prices of products do not fall easily because if wages do not go down, forms will avoid lowering their prices because that would reduce their profits. also price wars would cause extreme lowering of price which is avoided.

When is the economy in long run equilibrium?

when the AD curve and SRAS curve intersect at any point on the LRAS curve. Long run equilibrium = short run equilibrium when AD and SRAS intersect on the LRAS curve.

The inability of the economy to move into the long run.

if wages and prices do not fall easily this means the economy may get stuck in the short run.

keynesian curve has three sections

Section I: real GDP is low, price level remains constant as real GDP increases. there is a lot of unemployment of resources and spare capacity. Section II: real GDP increases are accompanied by increases in price level. employment of resources increase and wages and resource prices begin to increase meaning higher costs of production. then firms have to sell output at higher prices. at potential output unemployment equals the natural rate of unemployment. Section III: real GDP reaches a level beyond which it cannot increase anymore. full employment of resources price levels increase rapidly, firms are at maximum labour. any efforts on the part of firms to increase output only leads to an increase in price level.

Monetarist model

examines what happens to AS when the economy moves into the long run when all resource prices including wage change to match changes in the price level.

Keynesian economists Principle

possible for economies to remain in a position of short-run equilibrium for long periods of time. if a recession continues for a long enough times, wages and prices would eventually being to fall.