What Is Long Run Aggregate Supply?

Aggregate supply represents the total amount of goods and services that businesses within a nation are willing and able to produce and sell at a given price level during a specific period. This economic measure helps understand a country’s overall productive capacity and its ability to meet demand. The relationship between aggregate supply and the general price level is often depicted through an aggregate supply curve, which helps illustrate the dynamics of production across the economy.

Understanding Long Run Aggregate Supply

Long Run Aggregate Supply (LRAS) defines the total output an economy can sustainably produce when all its resources are fully employed and utilized efficiently. This concept is independent of the current price level, meaning that in the long run, the economy’s productive capacity is determined by its real resources, not by inflation or deflation. Wages and other input prices are considered flexible in the long run, allowing the economy to adjust and return to its natural rate of unemployment and full potential output.

The LRAS curve is vertical, signifying that changes in the price level do not affect the economy’s long-run productive capacity. This verticality illustrates that at full employment, an economy cannot produce more goods and services by simply increasing prices; instead, output is constrained by the available resources and technology. This maximum sustainable output level is often referred to as “potential output” or “natural rate of output”.

Potential output is not necessarily the absolute maximum production possible, but rather the output level achievable with full, efficient, and sustainable utilization of labor, capital, and technology. When the economy produces at its potential output, it implies that unemployment is at its natural rate, reflecting frictional and structural unemployment rather than cyclical unemployment.

Factors Influencing Long Run Aggregate Supply

The position of the Long Run Aggregate Supply curve is determined by factors that influence an economy’s productive capacity, causing shifts to the left or right. An increase in these factors shifts the LRAS curve to the right, indicating a greater potential output, while a decrease shifts it to the left.

Changes in the Labor Force

Changes in the labor force significantly impact LRAS. An increase in the quantity of labor allows for more overall production. Improvements in the quality of the workforce through enhanced education, training, and human capital development lead to increased productivity, enabling the economy to produce more with the same number of workers.

Capital Stock

The quantity and quality of capital stock are also determinants. Investment in physical capital, such as factories, machinery, and infrastructure, directly expands the economy’s productive capabilities. Technological advancements embedded in new capital or improvements in existing capital enhance efficiency and productivity, allowing for greater output from the same inputs.

Natural Resources

Natural resources play a role in an economy’s productive capacity. The discovery of new natural resources can increase an economy’s potential output. Conversely, the depletion of existing resources or inefficient resource management can constrain production and shift the LRAS curve to the left.

Technological Advancements

Technological advancements and innovation drive LRAS shifts. New technologies improve productivity and efficiency across industries, enabling more output to be produced with the same amount of resources. Research and development initiatives, along with policies that foster innovation, contribute to sustained economic growth by expanding the economy’s productive frontier.

Institutional Factors

Institutional factors, such as laws and regulations, influence LRAS. Policies that promote stable property rights, reduce burdensome regulations, or enhance the ease of doing business can incentivize investment and production, thereby boosting long-run aggregate supply. A well-functioning legal system and a stable political environment reduce uncertainty, encouraging long-term economic planning and investment that expand productive capacity.

Long Run Aggregate Supply Versus Short Run Aggregate Supply

The distinction between Long Run Aggregate Supply (LRAS) and Short Run Aggregate Supply (SRAS) centers on the flexibility of input prices and the time horizon considered in economic analysis. In the short run, some input prices are considered “sticky” or fixed. This stickiness means that firms can temporarily increase output by utilizing existing capacity more intensively. Consequently, the SRAS curve slopes upward, indicating that businesses will supply more output as the price level rises.

In contrast, the long run is a period sufficient for all prices, including nominal wages and other input costs, to become fully flexible and adjust to changes in the overall price level. This flexibility allows the economy to return to its potential output level, regardless of the price level. The LRAS curve is vertical because, in the long run, the economy’s productive capacity is determined by its real resources and technology, not by the price level. Therefore, a change in the general price level will not alter the total amount of goods and services the economy can produce at full employment in the long run.

Economic shocks affect SRAS and LRAS differently. A temporary increase in input costs, such as a sudden rise in oil prices, would shift the SRAS curve to the left, leading to higher prices and lower output in the short run. However, in the long run, if the economy’s underlying productive capacity remains unchanged, the LRAS curve would not shift; instead, wages and other prices would eventually adjust, allowing the economy to return to its potential output at a new price level. Similarly, an increase in aggregate demand might lead to higher prices and output above potential in the short run, but in the long run, the economy would self-correct, with prices rising further to bring output back to the LRAS. The short run can transition to the long run as these adjustments occur, ultimately aligning actual output with potential output.