Aggregate Supply Views

Short-Run vs. Long-Run in Macroeconomics

• Short-run: Factor costs (especially wages) are fixed.
• Long-run: Factor costs are variable and adjust to the price level.

Two Main Views on Aggregate Supply in the Long-Run

• Monetarist/New Classical view.
• Keynesian view.
• Both views can be used interchangeably in the IB Economics course.

Monetarist/New Classical View of LRAS

• Focuses on the distinction between the short run and long run.
• Advocates a different relationship between aggregate supply and price level in the long-run vs. the short-run.
• LRAS curve is vertical at potential output ($Y_p$).
• Potential output is the output level when all costs of production are variable.
• In the long run, wages and input prices adjust to match price level changes, keeping firms’ real costs constant. Thus, output remains the same regardless of price level changes.

Keynesian View of AS Curve

• Resource prices (especially wages) cannot fall, even after long periods.
• Focuses on the inability of an economy to move into the long run when there is downward price level pressure.
• Keynesian AS curve has three sections:
  • Horizontal section: At low output levels, significant underutilisation of resources allows firms to expand production without increasing costs.
  • Upward-sloping section: As output increases, some resources become scarce, pushing up wages and input prices, leading to increased final prices.
  • Vertical section: Beyond potential output ($Y_p$), all resources are employed, and further price increases do not lead to increases in real output.