Question

What shape is the long-run aggregate supply curve? Why does it have this shape?

Short answer

The long-run aggregate supply curve (LRAS) is vertical, indicating that output supplied by firms in an economy remains constant in the long run, irrespective of changes in the price level. This is because an economy's potential output, or real GDP, is determined solely by its factors of production and technology, which are not affected by price level fluctuations. The vertical LRAS curve reflects the idea that there is no trade-off between inflation and output in the long run.

Step-by-step solution

Defining the Long-Run Aggregate Supply Curve

The long-run aggregate supply curve (LRAS) represents the total quantity of goods and services that firms in an economy are willing and able to produce at various price levels when all their inputs, including labor and capital, are fully utilized. The LRAS curve reflects the aggregate production capacity of an economy over the long-run, which is determined by the available factors of production, technology, and the overall efficiency of resource allocation.

Identifying the Shape of the LRAS Curve

The shape of the long-run aggregate supply curve is vertical. This means that it is a straight, upward line when plotted on a graph with the price level on the vertical axis and the real output or real GDP on the horizontal axis. The LRAS curve intersects the horizontal axis at the level of potential GDP, which represents the maximum output an economy can produce in the long-run, given its factors of production and level of technology.

Explaining the Vertical Shape of the LRAS Curve

The vertical shape of the long-run aggregate supply curve signifies that the output supplied by firms remains constant in the long run, irrespective of changes in the price level. This is because, over the long run, an economy's potential output or potential GDP is determined solely by its factors of production and the level of technology, which are not affected by variations in the price level. In other words, the LRAS curve reflects the idea that in the long run, there is no trade-off between inflation and output, as suggested by the short-run relationship between aggregate supply and demand. Increases in the price level may lead to higher production in the short run (due to, for example, the money illusion where workers demand higher wages as prices rise), but these factors dissipate over time, and the economy returns to its potential output level.

Summarizing the Explanation

In conclusion, the long-run aggregate supply curve (LRAS) is a vertical line, which indicates that the output supplied by firms in an economy remains constant in the long run, regardless of changes in the price level. This is because the potential output (real GDP) of an economy is determined solely by its available factors of production (labor, capital, etc.) and the level of technology, both of which are not influenced by price level fluctuations in the long run.