The long-run aggregate supply curve is a vertical line at the potential level of output. The short-run aggregate supply curve is an upward-sloping curve that shows the quantity of total output that will be produced at each price level in the short run.

The long-run aggregate supply curve is perfectly vertical, which reflects economists’ belief that the changes in aggregate demand only cause a temporary change in an economy’s total output. For the short-run aggregate supply, the quantity supplied increases as the price rises.

The long-run aggregate supply curve is vertical because in the long run wages are flexible. The level of output that the economy would produce if all prices, including nominal wages, were fully flexible is called: -potential GDP.

When prices are sticky, the SRAS curve will slope upward. The SRAS curve shows that a higher price level leads to more output. For one, it represents a short-run relationship between price level and output supplied. Aggregate supply slopes up in the short-run because at least one price is inflexible.

A shift in aggregate supply can be attributed to many variables, including changes in the size and quality of labor, technological innovations, an increase in wages, an increase in production costs, changes in producer taxes, and subsidies and changes in inflation.

Why is the LRAS vertical? The LRAS is vertical because, in the long-run, the potential output an economy can produce isn’t related to the price level. The LRAS curve is also vertical at the full-employment level of output because this is the amount that would be produced once prices are fully able to adjust.

The long-run Phillips curve is a vertical line that illustrates that there is no permanent trade-off between inflation and unemployment in the long run. As unemployment rates increase, inflation decreases; as unemployment rates decrease, inflation increases.

Key terms

The Keynesian aggregate supply curve shows that the AS curve is significantly horizontal implying that the firm will supply whatever amount of goods is demanded at a particular price level during an economic depression.

The Keynesian AS curve is perfectly elastic when there is substantial spare capacity but becomes progressively more inelastic as spare capacity diminishes. The change in the elasticity of the AS curve means that the impact of AD shifts will result in differential outcomes for price level and real output.

Aggregate supply curve showing the three ranges: Keynesian, Intermediate, and Classical.

Keynesians believe that the aggregate supply curve is horizontal in the short run. The Classical model assumes prices are flexible so that the aggregate supply curve is vertical and the economy is always at full employment. short-run aggregate supply is horizontal.

The aggregate supply curve shows the relationship between the price level and the quantity of goods and services supplied in an economy. The equation for the upward sloping aggregate supply curve, in the short run, is Y = Ynatural + a(P – Pexpected).

Which of the following factors could cause the economy to experience​ supply-side inflation? Government laws which say that the average work week must be reduced by one hour every year. An increase in​ long-run aggregate supply cuases the price level to​ increase, and is therefore inflationary.

The aggregate supply curve Aggregate supply, or AS, refers to the total quantity of output—in other words, real GDP—firms will produce and sell. The aggregate supply curve shows the total quantity of output—real GDP—that firms will produce and sell at each price level.

What Is the IS-LM Model? The IS-LM model, which stands for “investment-savings” (IS) and “liquidity preference-money supply” (LM) is a Keynesian macroeconomic model that shows how the market for economic goods (IS) interacts with the loanable funds market (LM) or money market.

LRAS shifts only when the potential GDP increases or decreases. Figure 3. A Demand Shock. When AS shifts in response to a shift in AD, potential GDP (and LRAS) is unchanged.

How productivity growth shifts the AS curve. In the long run, the most important factor shifting the SRAS curve is productivity growth. Productivity—in economic terms—is how much output can be produced with a given quantity of labor. One measure of this is output per worker, or GDP per capita.

The aggregate demand curve shifts to the right as the components of aggregate demand—consumption spending, investment spending, government spending, and spending on exports minus imports—rise. If the AD curve shifts to the right, then the equilibrium quantity of output and the price level will rise.

Economists define a recessionary gap as a lower, real-income level, as measured by real GDP, than the real-income level at a point of full employment. In the period leading up to a recession, there is often a significant reduction in consumer expenditure or investment due to a decrease in the take-home pay of workers.

In the long run, the investment will increase the economy’s capacity to produce, which shifts the LRAS curve to the right. The combined effects are that the economy grows, both in terms of potential output and actual output, without inflationary pressure.

Along with energy prices, two other key inputs that may shift the SRAS curve are the cost of labor, or wages, and the cost of imported goods that we use as inputs for other products. Note that, unlike changes in productivity, changes in input prices do not generally cause LRAS to shift, only SRAS.

The long-run equilibrium of a perfectly competitive market occurs when marginal revenue equals marginal costs, which is also equal to average total costs.

Cost-push inflation is when supply costs rise or supply levels fall. Either will drive up prices as long as demand remains the same. Shortages or cost increases in labor, raw materials, and capital goods create cost-push inflation. These components of supply are also part of the four factors of production.

Very low inflation usually signals demand for goods and services is lower than it should be, and this tends to slow economic growth and depress wages. This low demand can even lead to a recession with increases in unemployment – as we saw a decade ago during the Great Recession.

What are the three effects of inflation? Decrease in the value of the dollar, increase interest rate in loans, decreasing real returns on savings.

A famous example of cost-push inflation occurred in the 1970s oil market. The price of oil is controlled by an intergovernmental body known as OPEC—the Organization of Petroleum Exporting Countries. In the Seventies, OPEC imposed higher prices on the oil market; however, demand had not increased.

Specifically, they distinguish between two broad types of inflation: cost-push inflation and demand-pull inflation.

• Cost-push inflation results from general increases in the costs of the factors of production.
• Demand-pull inflation results from an excess of aggregate demand relative to aggregate supply.

Policies to reduce cost-push inflation are essentially the same as policies to reduce demand-pull inflation. The government could pursue deflationary fiscal policy (higher taxes, lower spending) or monetary authorities could increase interest rates.