20.4 The Aggregate-Supply Curve
20.4 a. Why the Aggregate-Supply Curve is Vertical in the Long Run
The long-run aggregate supply curve is vertical which reflects economists’ beliefs that changes in the aggregate demand only temporarily change the economy’s total output. In the long-run, only capital, labor, and technology affect aggregate supply because everything in the economy is assumed to be used optimally. The long-run AS curve is static because it is the slowest aggregate supply curve [14].
Long-Run Aggregate Supply [15]
20.4 b. Why the Long-Run Aggregate-Supply Curve Might Shift
The long-run aggregate supply curve can be shifted, when the factors of production change in quantity. Similarly, changes in technology can shift the curve by changing the potential output from the same amount of inputs in the long-term [14].
Example: If there is an increase in the number of available workers or labor hours in the long run, the aggregate supply curve will shift outward (it is assumed the labor market is always in equilibrium and everyone in the workforce is employed) [14].
Long-Run Aggregate Supply [15]
20.4 c. Using Aggregate Demand and Aggregate Supply to Depict Long-Run Growth and Inflation
We can examine long-run economic growth using the AD/AS model, but the factors that determine the speed of this long-term economic growth rate do not appear directly in the AD/AS diagram. Cyclical unemployment is relatively large in the AD/AS framework when the equilibrium is substantially below potential GDP and relatively small when the equilibrium is near potential GDP. The natural rate of unemployment—as determined by the labor market institutions of the economy—is built into potential GDP, but does not otherwise appear in an AD/AS diagram. Pressures for inflation to rise or fall are shown in the AD/AS framework when the movement from one equilibrium to another causes the price level to rise or to fall [17].
Example: When an AD/AS diagram shows an equilibrium level of real GDP substantially below potential GDP it indicates a recession. On the other hand, in years of resurgent economic growth the equilibrium will typically be close to potential GDP [17].
Long-Run Growth, Recession and Inflation [18]
20.4 d. Why the Aggregate-Supply Curve Slopes Upward in the Short Run
If firms across the economy face a situation where the price level of what they produce and sell is rising but their costs of production are not rising, then the lure of higher profits will induce them to expand production [10].
Example: A firm will be incentivized to produce more if the price level increases and price of inputs like labor and energy remain constant [10].
Short-Run Aggregate Supply [16]
20.4 e. Why the Short-Run Aggregate-Supply Curve Might Shift
Any event that results in a change of production costs shifts the short-run supply curve outwards or inwards if the production costs are decreased or increased. Factors that impact and shift the short-run curve are taxes and subsides, price of labor (wages), and the price of raw materials. Changes in the quantity and quality of labor and capital also influence the short-run aggregate supply curve [14].
Example: Events that shift the aggregate supply curve to the right include a decrease in wages, an increase in physical capital stock, or advancement of technology [14].
Short-Run Aggregate Supply [16]
