Macroeconomics

‭The shape of the LRAS curve is justifed as follows:‬

‭1.‬ ‭Prices‬‭in‬‭the‬‭long‬‭run‬‭are‬‭fully‬‭flexible‬ ‭,‬‭so‬‭producers‬‭can‬ ‭fully‬‭adjust‬‭their‬‭prices‬ ‭allowing‬‭the‬ ‭economy‬ ‭to‬ ‭produce‬ ‭the‬ ‭effcient,‬ ‭full-employment‬ ‭output‬ ‭level‬ ‭.‬ ‭At‬ ‭this‬ ‭level‬ ‭of‬ ‭output,‬ ‭resources‬‭are‬‭fully‬‭employed‬‭and‬‭utilized‬ ‭,‬‭so‬‭there‬‭is‬‭no‬‭way‬‭to‬‭produce‬‭any‬‭additional‬‭output‬ ‭with‬‭the‬‭current‬‭quantity‬‭and‬‭quality‬‭of‬‭resources.‬‭A‬‭vertical‬‭LRAS‬‭curve‬‭is‬‭said‬‭to‬‭be‬ ‭“perfectly‬ ‭inelastic”‬ ‭, which means that‬ ‭a change in the price‬‭level will have‬ ‭no effect‬ ‭on output.‬ ‭2.‬ ‭In‬‭the‬‭long‬‭run,‬‭the‬‭potential‬‭output‬‭an‬‭economy‬‭can‬‭produce‬‭is‬ ‭not‬‭related‬‭to‬‭the‬‭price‬‭level‬ ‭(perfectly‬ ‭inelastic‬ ‭LRAS‬ ‭curve).‬ ‭Potential‬ ‭output‬ ‭or‬ ‭potential‬ ‭GDP‬‭or‬‭full‬‭employment‬‭GDP‬ ‭is‬ ‭defned‬ ‭as‬ ‭the‬‭level‬‭of‬‭output‬‭that‬ ‭an‬‭economy‬‭can‬‭sustain‬‭in‬‭the‬‭long‬‭run‬‭without‬‭inflation‬ ‭.‬ ‭Potential GDP is rather affected by the quantity and/or quality of resources.‬ ‭It‬ ‭is‬ ‭important‬ ‭to‬ ‭note‬ ‭that‬ ‭the‬ ‭vertical‬ ‭LRAS‬ ‭curve‬ ‭is‬ ‭a‬ ‭New‬ ‭Classical‬ ‭view‬ ‭of‬ ‭LRAS‬ ‭.‬ ‭Classical‬ ‭Macroeconomic‬ ‭Theory‬ ‭is‬‭based‬‭on‬‭the‬‭belief‬‭that‬ ‭market‬‭forces,‬‭such‬‭as‬‭supply‬‭and‬‭demand,‬‭work‬ ‭effciently‬ ‭to‬ ‭bring‬ ‭an‬ ‭economy‬ ‭to‬ ‭its‬ ‭full‬ ‭potential,‬ ‭known‬ ‭as‬‭the‬‭Natural‬‭Rate‬‭of‬‭Unemployment‬ ‭(NRU)‬ ‭.‬ ‭Recall‬ ‭that‬ ‭NRU‬ ‭represents‬ ‭full‬ ‭employment,‬ ‭which‬ ‭does‬ ‭not‬ ‭mean‬‭zero‬‭unemployment,‬‭since‬ ‭frictional‬ ‭and‬ ‭structural‬ ‭unemployment‬ ‭are‬ ‭unavoidable‬ ‭as‬ ‭seen‬ ‭in‬ ‭Chapter‬ ‭2.‬ ‭According‬ ‭to‬ ‭New‬ ‭Classicals,‬ ‭if‬ ‭there‬ ‭is‬ ‭unemployment,‬ ‭it‬ ‭is‬ ‭primarily‬ ‭due‬ ‭to‬ ‭frictional‬ ‭and‬ ‭structural‬‭factors,‬‭not‬‭due‬‭to‬ ‭cyclical‬ ‭downturns‬ ‭in‬ ‭the‬‭economy.‬ ‭In‬‭the‬‭long‬‭run,‬‭the‬‭economy‬‭is‬‭considered‬‭to‬‭be‬‭self-adjusting,‬ ‭and‬ ‭government‬ ‭intervention‬ ‭is‬ ‭generally‬ ‭seen‬‭as‬‭unnecessary‬ ‭.‬‭Therefore,‬‭the‬‭economy‬‭will‬‭always‬ ‭operate at full capacity in the long run.‬ ‭Determinants of Aggregate Supply: Shifts of the LRAS Curve‬ ‭In‬ ‭the‬ ‭long‬ ‭run,‬ ‭attempts‬ ‭to‬ ‭use‬‭existing‬‭resources‬‭more‬‭intensively‬‭(e.g.,‬‭encouraging‬‭overtime‬‭work,‬ ‭attracting‬‭more‬‭workers‬‭into‬‭the‬‭labor‬‭force,‬‭etc.)‬‭will‬‭only‬‭cause‬‭an‬‭increase‬‭in‬‭the‬‭costs‬‭of‬‭production,‬ ‭and‬ ‭ultimately‬‭an‬‭increase‬‭in‬‭the‬‭price‬‭level,‬‭but‬‭with‬‭no‬‭change‬‭in‬‭output‬ ‭.‬‭The‬‭economy‬‭would‬‭still‬ ‭operate at the LRAS but on a higher point where the price level is higher but output is the same.‬

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