Long Run Aggregate Supply - Online Tutor, Practice Problems & Exam Prep

Long-run aggregate supply (LRAS) is determined by the availability of factors of production, such as labor, capital, natural resources, and technology. In the long run, real GDP remains constant regardless of the price level, represented by a vertical LRAS curve. Shifts in LRAS occur due to changes in these factors; for instance, increased labor or improved technology shifts LRAS to the right, indicating higher potential output. Conversely, a decrease in resources or labor shifts it to the left, reducing long-run production capacity.

LRAS

So when we talk about aggregate supply, we have to discuss aggregate supply in the short run and in the long run separately. They're going to look different on the graph. Let's start with the long run and then we'll do short run in another video. So we're still here in the aggregate demand, aggregate supply model and we're explaining short run fluctuations in GDP and price. But long run aggregate supply is still important because we're going to have a long run equilibrium and short run equilibrium when we look at the graph together. So, let's go ahead and describe long run aggregate supply, which we're going to label LRAS.

In the long run, the quantity of GDP, or real GDP, which is the amount of goods and services that are being produced, depends on the availability of resources. If we consider the long run, well, the amount of GDP we're going to be able to produce, it depends on what resources we have available to make products. How much of our factors of production, these resources, are available? How much labor, capital, natural resources, and technology are available? In the long run, we're going to be limited by these factors. There's going to be some total amount that we can produce, and we're going to run out of labor and capital. There won't be anything left to produce anymore because everything will be utilized.

The current price level does not affect real GDP because when we talk about real GDP, we focus on the quantity of goods that can be created, not just the dollar value of goods. Real GDP is calculated using base year prices so that the price level doesn't interfere. We're focused on a quantity of goods that are being produced, and the only thing that affects that is the availability of factors of production. Once we have a certain amount of factors of production, the price level doesn't matter for the amount we can produce.

Remember, when we deal with the graph in this model, the ADAS model, the price level is on our y-axis and our real GDP is on our x-axis. The price level doesn't affect the amount of real GDP, only the amount of factors of production we have. So, if at any point in time, we have a certain amount of factors of production, such as the population, the working force of the economy, the amount of factories and equipment we have, the education of those people, and how much natural resources like oil or lumber we have available, the price level isn't going to affect what we can produce in the long run.

What we see in the graph is a straight vertical line for our long run aggregate supply, or LRAS. This line is always going to be vertical because the price level doesn't affect how much we can produce in the long run, no matter whether we have high prices, medium prices, or low prices. We're always able to produce this amount of GDP in the long run. This is the GDP in the long run and the potential of our society, the total potential of our society if we have full employment and are utilizing all our resources, regardless of the price level. The long run aggregate supply is always a direct, straight up and down line.

This is how we define our long run aggregate supply, based on those available resources. But just like any other curves, this long run aggregate supply can shift left and shift right for different reasons, and that would be because of the factors of production. If we have more people in the economy, we're going to have more GDP possible in the long run. If we have smarter people or more natural resources, those are all going to shift our graph. Let's pause here and let’s talk about those shifts in the next video.

Shifting LRAS

So let's talk about these different factors of production and how they can affect our long run aggregate supply. So we're going to talk about good shifts, right? Things that can shift it to the right, meaning we'll have more long run aggregate supply or bad things that can shift it to the left, right? Things that will make it so our economy can't produce as much in the long run. That's a little hard to see. Let me do it in black. Shift right and shift left. Okay? So labor, the amount of labor that we have in our society. What it comes down to with all of these is if there's more of these factors of production, then we're going to be able to shift to the right. If there's less of them, we're going to have to shift to the left. So, immigration, right? If there's immigration to the USA, well, we would shift to the right, right? There are more people, more people available to work. It's going to shift us to the right and the opposite. If people are leaving the USA, and I'm just using the USA as an example, it can be any country, right? There's going to be less, less available labor and less long run aggregate supply. Less we can possibly produce in our economy, Okay? So the more people there are, simple enough. There are more people available to work.

How about physical capital? Physical capital, remember this is the amount of factories, the amount of equipment. So, you can imagine if there's more factories, that would be a good thing. That would shift us to the right because there are more factories, more productivity that we can get from all of our labor. And fewer factories, less available physical capital would lead to lower aggregate supply. So when I say we're shifting left or right, let me just go to the graph real quick just to reiterate. Let's say there was immigration to the U.S. They said there's a big influx of immigration to the US. We would shift this curve to the right to a new long run aggregate supply out here. This would be long run aggregate supply 2. Right? This would be 1 and we would shift it to the right because of one of these underlying factors. Right? So that's what would happen. We would shift it to the right or to the left, but it would still be vertical just like that.

So let's go on to the next one here, human capital. So, let's say there's free college. Right? Free college education. Well, that makes all of our workers more technically savvy. They're smarter. They're able to be more productive when they're working, right? So the more human capital they have, the more productive they're going to be and it's going to shift us to the right. And no education, right? If there's no public education or no education available, well, that's bad. They're not going to be as productive. They're all uneducated people and they're not going to be able to produce as much. Okay?

How about natural resources? So natural resources, what if we find a huge oil deposit and it brings down the price of oil and there are more natural resources available in the economy to be used. Well, then we would shift to the right. What if there's a war and we lose key resources, right? We lose maybe some Russia takes away Alaska where we have huge oil deposits and we no longer have it anymore, right? Whatever it might be. Well, if we don't have those, it's going to shift to the left there.

Lastly, we have technology here. And you can imagine technology generally only moves one way. So more technology, right? If there's some new sort of technological improvement, well, it's going to shift us to the right. And I don't know. Some sort of catastrophic event that, like, destroys the Internet or something. I don't know what could really lower our technology. That's probably not going to come up at all. That'd be it's kind of tough to use an example for that. But in general, technology, if there's new technology, more available technology, it's going to make people more productive, make things happen quicker and more efficiently and we would shift our long run aggregate supply to the right. Okay? So that's how we are going to deal with long run aggregate supply. Now, let's deal with the short run.

Here’s what students ask on this topic:

What is long-run aggregate supply (LRAS) and how is it represented on a graph?

Long-run aggregate supply (LRAS) represents the total output an economy can produce when utilizing all its resources efficiently. It is determined by the availability of factors of production such as labor, capital, natural resources, and technology. On a graph, LRAS is depicted as a vertical line because, in the long run, real GDP remains constant regardless of the price level. This vertical line indicates the economy's potential output or full employment output, where all resources are fully utilized.

What factors can cause the long-run aggregate supply curve to shift?

The long-run aggregate supply (LRAS) curve can shift due to changes in the factors of production. An increase in labor, capital, natural resources, or technological advancements will shift the LRAS curve to the right, indicating higher potential output. Conversely, a decrease in these factors will shift the LRAS curve to the left, reducing the economy's long-run production capacity. For example, immigration can increase labor supply, shifting LRAS to the right, while a natural disaster that destroys resources can shift it to the left.

How does technological advancement affect long-run aggregate supply?

Technological advancement positively affects long-run aggregate supply (LRAS) by increasing productivity and efficiency in the production process. When new technologies are introduced, they enable workers and capital to produce more output with the same amount of input. This improvement shifts the LRAS curve to the right, indicating a higher potential output for the economy. For instance, the advent of the internet and automation has significantly boosted productivity, leading to an increase in long-run aggregate supply.

Why is the long-run aggregate supply curve vertical?

The long-run aggregate supply (LRAS) curve is vertical because, in the long run, the total output of an economy is determined by the availability of factors of production (labor, capital, natural resources, and technology) and not by the price level. This means that changes in the price level do not affect the economy's potential output. The vertical LRAS curve represents the maximum sustainable output an economy can produce when all resources are fully utilized, regardless of price changes.

How does an increase in labor affect the long-run aggregate supply curve?

An increase in labor, such as through higher birth rates, immigration, or improved labor force participation, shifts the long-run aggregate supply (LRAS) curve to the right. This shift indicates a higher potential output for the economy because more workers are available to produce goods and services. For example, if a country experiences significant immigration, the additional labor force can contribute to higher production levels, thereby increasing the economy's long-run aggregate supply.