Shifts in Long run Aggregate Supply

4 Key excerpts on "Shifts in Long run Aggregate Supply"

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  eBook - ePub

  Macroeconomics

  (With Study Guide CD-ROM)

  • Jagdish Handa(Author)
  • 2010(Publication Date)
  • WSPC

    (Publisher)

  y*) = 0. However, we cannot take it for granted that the real-world economies will meet these assumptions for each period of our study, when these periods are as short as, say, a month, a quarter, or a year. We, therefore, resorted to the analytical notion of the long run, which is defined as the stage in which these assumptions are met, so that the economy can be said to be at the full-employment (LR) level of output.

  Hence, the aggregate supply curve for the full-employment level of output is called the LR aggregate supply (LRAS) curve. It is applicable in the case of zero expectational errors, zero adjustment costs and lags, and equilibrium in the labor market and in production. It is strictly not applicable when these conditions are not met. However, the LR levels of output and employment can be used as a benchmark or reference state toward which the economy will tend to move. If it does not do so of its own volition or does not do so fast enough, macroeconomics (see Chapters 8 and 9 ) examines the policies that can induce such a movement.

  7.11.1 Changes in the actual rate of output over time

  The actual level of output alters over time because of changes in any or all of its three components since:

  As we have argued earlier, the full-employment level of output does change over time due to shifts in technology and in labor supply. The other two components of the actual level can also change and do change over the business cycle. In particular, they are positively related to the business cycle and tend to have positive values during a boom than during a recession. They can be changed by monetary and fiscal policies.

  7.12 The Rate of Unemployment

  This chapter has focused on the long-run analysis of output and employment. Changes in unemployment and its rate are the converse of those in employment, so that we now derive the implications of the long-run analysis for unemployment. Chapter 10

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  eBook - ePub

  Macroeconomics For Dummies

  • Dan Richards, Manzur Rashid, Peter Antonioni(Authors)
  • 2016(Publication Date)
  • For Dummies

    (Publisher)

  Chapter 10 for details). In the short run, the interaction of aggregate supply and aggregate demand determines how much a country produces (GDP) and how much on average those goods will cost to purchase (the price level), as well as how fast that price level is changing (inflation), plus how much unemployment an economy experiences.

  Looking at long-run aggregate supply

  Economists distinguish between the short run and the long run because the economy behaves in a different way depending on the time frame you’re looking at. The important thing about the long run is that prices are fully flexible (they can change a lot), whereas in the short run prices are sticky (they don’t change by very much — check out the later section “Pulling apart why prices can be sticky ” for some suggested causes of this stickiness).

  Saying that prices are sticky is a way of saying something important about the behavior of suppliers. When demand for any product increases, the businesses that make those goods can do one of three things:

  • Hold output constant and raise their price until the extra demand is choked off
  • Hold the price constant and increase supply enough to meet all the new demand
  • Do a bit of both

  The same options arise for the workers, who supply labor, and the capitalists who supply capital to the firms. In response to a rising demand for their services, they can supply more labor and capital services, raise their compensation demands, or, again, do some of both.

  In the long run, it’s the first option that best describes agents’ behavior in a macro sense. Given enough time, a rise in demand leads to a higher overall aggregate price level P (and higher wages, too) but no more output. In the short run, it’s the second choice that rules. Initially, prices and wages are held in check in response to a demand shock. The result is that, in the short run, a rise in demand evokes mostly an increase in production, whereas a fall in demand induces production to fall. In this section, we review briefly the long-run supply behavior, which is really what the growth model of Chapter 8

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  Contemporary Economics

  An Applications Approach

  • Robert Carbaugh(Author)
  • 2016(Publication Date)
  • Routledge

    (Publisher)
• The model of aggregate demand and aggregate supply can be used to show how output and prices are determined in the short run. An economy is in equilibrium when aggregate demand equals aggregate supply.
• The aggregate demand curve shows the total amount of real output that buyers will purchase at alternative price levels during a given year. Movements along an aggregate demand curve are caused by changes in the price level of the economy. Shifts in the aggregate demand curve are caused by changes in non-price factors that affect household consumption expenditures, business investment, government expenditures, and net exports of goods and services.
• According to the multiplier effect, a change in any one of the components of aggregate demand (consumption, investment, government spending, or net exports) will have a magnified impact on national output and income. The size of the multiplier depends on the spending and saving habits of consumers and businesses.
• The aggregate supply curve shows the relationship between the level of prices and amount of real output that will be produced by the economy in a given year. The aggregate supply curve is horizontal when the economy is in deep recession or depression, upward-sloping when the economy approaches full employment, and vertical when the economy achieves full employment. Changes in factors such as resource prices, resource availability, and the level of technology will cause the aggregate supply curve to shift.
• The model of aggregate demand and aggregate supply can be applied to the problems of recession and inflation. According to this model, decreases in aggregate demand or aggregate supply can push the economy into recession; inflation may be the result of increases in aggregate demand or decreases in aggregate supply. An economy experiences “stagflation” when there is both recession and inflation.