Long-Run Aggregate Supply

There is another concept in the aggregate supply-aggregate demand model that is not present in the standard supply-demand model, and that is the long-run aggregate supply (LRAS) curve. The LRAS curve reflects the economy’s potential output when all resources are fully utilized (but not overutilized), and when there are no temporary frictions or imbalances in the economy. The LRAS is vertical because the price level does NOT affect the economy’s potential output in the long run. In the long-run, the economy operates at its full employment level of output, known as potential GDP or full employment GDP.

While the LRAS is vertical, it can slowly shift over time. Though the LRAS assumes that all resources are fully utilized, the LRAS can shift to the right as the productive capacity of the economy increases (it can also shift to the left as the productive capacity decreases, but this is more rare). For example, if a new technology is developed that makes production more efficient, the LRAS can shift to the right because the productive capacity itself has increased. Rightward shifts in the LRAS represent long-term economic growth (rather than the fluctuations in the business cycle that can be represented in the SRAS and AD curves) and higher living standards.