Long run aggregate supply

In micro-economics, the long run refers to a situation when producers can increase the output of their goods and services without any short-run constraints in terms of fixed factors. In the long run all factors of production can be increased, including capital assets.

In terms of macro-economic analysis, the aggregate supply in the long run refers to how much real output - in terms of its monetary value - can be produced using all of the economy's scarce resources - labour, enterprise, capital, land and other natural resources.

In measuring aggregate supply in the long run it is assumed that the quantity and quality of output is not determined by the price level, but by other determinants including the quantity of factors, how efficiently they are used, the use of new technology and other factors that 'add value'.

The incentive to supply is driven by the pursuit of profits, and changes in the general price level are assumed to have no impact on profits in the long run.

The long run aggregate supply curve

The long run aggregate supply curve (or LRAS curve) is assumed to be a vertical curve at the economy’s current capacity (at YF).

The position of the LRAS curve is not determined by the price level, but by factors that affect the capacity of firms in the economy.

In the long run, and assuming normal levels of inflation – somewhere between 2 and 5% - the price level has little bearing on output.

However, the quantity and quality of factors, including 'human capital', the use of technology, and the productivity of factors, do have an influence on the capacity of the economy, and therefore on the position of the LRAS curve.

Although vertical, the LRAS can shift if productive potential changes, such as when education and training, or new technology, improves labour productivity.

Long run aggregate supply

Video on long run aggregate supply

It is assumed that the LRAS curve is influenced more by supply-side policy than fiscal or monetary policy.

Does money and monetary policy affect long run supply?

It has been a fairly long held belief that 'money is neutral' in its effect - the argument goes that changes in the money supply affect the price level, and because changes in the price level do not affect long run supply, then money and monetary policy have little bearing on the long run aggregate supply curve.

However, this position can be challenged - changes in monetary conditions can influence investment decisions, which can then increase an economy's capacity to produce. Research by Òscar et al 1 also indicates that monetary shocks can have long lasting effects on real national output.

Long run aggregate supply

Productivity and long run aggregate supply

Labour productivity (output per worker or output per hour worked) is a key determinant of an economy’s ability to produce in the long run. There are three key factors that determine productivity:

  1. Human capital – this refers to the sum of the accumulated knowledge, skills and expertise gained from formal and informal education and training. Improvements in education and training will improve productivity and enable supply to increase in the long run.
  2. Use of new technology – invention and innovation and its incorporation in new technology enables productivity to increase.
  3. Scale economies – as firms increase their scale they can make efficiency gains which convert to productivity improvements.

Aggregate demand

Aggregate demand and the AD curve.

Aggregate demand
Fiscal policy

How can fiscal policy influence aggregate demand?

Fiscal policy
Monetary policy

How effective is supply-side policy?

Supply-side policy

1. Jordà, Òscar, Sanjay R. Singh, Alan M. Taylor. 2020. “The long-run effects of monetary policy,” Federal Reserve Bank of San Francisco Working Paper 2020-01; Viewed March 3 2021 https://doi.org/10.24148/wp2020-01
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