3.4-3.5 Long-Run Aggregate Supply and Equilibrium

Short Run vs. Long Run

• Short run - Input prices are fixed due to sticky wages and prices

• Long run - ALL input prices are variable, so LRAS is vertical

  • fully flexible wages and prices

  • producers will use all available resources

Long Run Aggregate Supply

maximum production possible

regardless of increase in price, economy is at full employment and capacity

input costs are all variable

• like business cycle potential output curve and PPC

Operating at Full Employment =

= Potential Output = LRAS

Price Level

does NOT affect production factors variables in the long run bc input prices are fully flexible, and firms can produce at ANY price level

Trade Offs between Inflation and Unemployment

there are none

Recessionary Gap

• short run equilibrium is left of LRAS, gap is called recessionary gap

• HIGH unemployment

• this economy needs a boost of more output or more demand

  • more GDP!!

gov increases AD to fix

Long-Run Equilibrium

• when short run equilibrium (where SRAS and AD meet) intersects at the LRAS curve, current level of production equals the natural rate of output

• a country is currently operating at full-employment (at NRU)

Inflationary gap

• when operating ABOVE the natural rate of output

• the short run equilibrium is right of the LRAS called inflationary gap

• this economy is growing TOO FAST! its too hot and is not sustainable

• they need LESS DEMAND

• HIGH inflation

AD decreases to fix

LRAS Shifters

wont happen often but…

• occurs when Natural Rate of Output/unemployment changes, including:

1. Changes to long term productivity (will be directly stated by question)

2. changes to capital stock (total amt capital in a country)

3. long term changes in:

   1. investment (bc improves capital)

   2. technology

   3. population