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Macroeconomics
Course: Macroeconomics > Unit 3
Lesson 4: Long-run aggregate supplyLong-run aggregate supply
Learn about the concept of aggregate supply, focusing on the long-run. You'll see how, in long-run cases, real GDP is not dependent on prices, and that aggregate supply can be seen as a "natural level of productivity." You'll also learn how factors, such as population growth, technological improvements, or even war, can shift aggregate supply over time. Created by Sal Khan.
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I still does not get, how the change of price does not affect the long- run aggregate supply. I will really appreciate if someone can give more simple examples for me to be able to understand this concept.(17 votes)
In the long run, the price doesn't matter because any increases or decreases in price will be cancelled out by decreases or increases in costs (wages, input costs, etc.). If prices double, so do wages, so people have no additional spending power. Firms will produce the same and households will buy the same.
This is an example that's not related to macroeconomics nor supply, but I hope it can help clarify:
If you have $2 and apples cost $1, you can buy 2 apples. If prices double, in the long run so will incomes. You now have $4 and apples cost $2. You can still buy 2 apples.(50 votes)
- Question about the "vertical line" that is supposed to be insensitive to price. What if a particular economy is based on a very crucial input factor that is required by all dependent industries? Lets say the GDP of a small country is substantially based on the input X (may be some kind of mineral produced in the same country) - both through the production of X and the industries that subsequently use X. Lets also say that the production of X and the dependent industries of X (that produce Y) contribute to the GDP 50-50.
If the price of X increases (also effecting the "P"), the dependent industries may not be able to afford X anymore and those industries might shut down completely. This may happen if foreign countries can produce the same Y, but without using X (e.g. blue meth by Walter White?)
So in this example, the price increase of X, may have destroyed the dependent industries that produce Y and have effected the GDP. How am I wrong here? Thx.(10 votes)- Very good question. I'd give you an upvote for it, but I already gave you one for the Breaking Bad reference.
A shock, such as you described, could shift the curve, which has a very different impact than a change in price level. All the long run aggregate supply curve is saying is that given any price level, the economy has some level of natural output it can produce. If massive inflation makes prices triple overnight, your country can still produce the same amount in the long run.
In essence, you've basically explained the 1973 oil crisis. Oil become extremely expensive, which had an impact on every other industry (either directly or indirectly). High costs drove many firms out of business, while others innovated to reduce the dependence on foreign oil (they "produced Y without using X," essentially).(12 votes)
- Is there a video covering fiscal policy and open market operations on the ASAD model and going through all four graphs that come as impact? Im trying to prepare for my IB exams and the video playlist goes slow paced.(5 votes)
how do i know when to use long run/ short run for aggregate supply?(6 votes)- Short-run aggregate supply (SRAS) typically measures the willingness and ability of producers to supply goods and services now or in the near future -- anywhere from a few weeks to a couple of years' time frame. Thus, SRAS is more responsive to changes in conditions which impact producers' willingness and ability to produce (such as changes in fiscal policy or profitability).
Long-run aggregate supply (LRAS) measures long-term national output -- the normal amount of real GDP a nation can produce at full employment. As such, it does not change much, if at all, to short-term changes that affect producers' willingness and ability to produce. Rather, it responds slowly to long-term conditions that affect the absolute amount of goods and services than could be produced (such as changes in population levels, technological advances, or additional resources).(9 votes)
What is the difference between Short Run Aggregate Supply (SRAS), and Long Run Aggregate Supply (LRAS)? And is there such a thing as Short Run Aggregate Demand(SRAD), and Long Run Aggregate Demand (LRAD)?(3 votes)
I still don't understand why LRAS is vertical. I've watched this video three times, and something is just not making sense to me. Help!(2 votes)
The LRAS is vertical because at full employment no more can possibly be produced thus it remains constant even when everything else is changing and is not affected(2 votes)
If the average price level in an economy increases, wont it give incentive to the producers to produce more as they will then be earning higher profits? Shouldn't the real GDP increase with the increase in avg. price level that way?(1 vote)
That's actually kind of what the SRAS curve is saying (except for the profit part)! There is an idea called Misperceptions Theory, when producers see an increase in the price level in aggregate, they mistake that as being an increase in the price of the good they are selling (i.e., at the market level). So, they respond by producing more.
However, the key thing to keep in mind is that GDP only counts what is sold. For example, say an automaker sees the price level go up (for some reason) and thinks, "Wow! People really want to buy cars! I should make some more cars!" and she makes 10 more cars. The cost of producing each car is $10,000. That production gets counted in GDP. The cars are priced at $15,000 each. But from the buyers persepective, the are saying "gee, everything is more expensive, and my employer didn't give me a cost of living increase in pay this year, I need to cut back on everything." Then those cars just sit in inventory, and the additional $5000 doesn't get counted. The automaker doesn't make higher profits (in fact, they probably are losing money).(4 votes)
Would Aggregate Supply line not be vertical if the x-axis represented Nominal GDP as opposed to real GDP? In that case, the AS line would likely be a curve or line with some positive slope, yes?(2 votes)- If demand increases, long run agregate supply wouldn't really be vertical. Supply adjust to quantities. I know that is theoretically accepted but i don't believe it. Actually, factors of production are more flexible in the long run...(1 vote)
Demand changing does not affect long run aggregate supply. Increasing demand, therefore, simply cannot make long run aggregate supply less vertical. Supply does not adjust to quantities. In fact, quantity is dependent on supply and demand. Factors of production are completely flexible in the long run, which is actually what makes the long run aggregate supply vertical.
However, the fact that long run aggregate supply is vertical doesn't mean that it can't shift. It can and does shift with technology, with resource costs, with regulation, and more. If resource costs are lower and technology is better, then long run aggregate supply would be further to the right than an economy where technology is poorer and resource costs higher.(3 votes)
- Can the Aggregate Supply curve in the Long run be not a positively sloped one? If yes, what the assumptions will be?(2 votes)
Video transcript
Narrator: We've talked a lot about aggregate demand over the last few videos, so in this video, I thought I would talk a little bit about aggregate supply. In particular, we're going to think about aggregate supply in the long-run. In economics, whether
it's in micro or macro economics, when we think about long-run, we're thinking about
enough time for a lot of fixed costs and a lot of
fixed contracts to expire. In the short-term, you
might be stuck into some labor contract, or stuck
into your using some factory that you've already paid
money for, so it was a fixed cost, but over the long-run
you'll have a chance that factory will wear down
and you'll have a chance to decide whether you
want another factory or the price of the factory might change; or in the long-run, you'll have a chance contracts will expire,
and you'll have a chance to renegotiate those
contracts at a new price. That's what we really mean when we talk about the long-run. I'm going to plot aggregate
supply on the same axis as we plotted aggregate
demand, and we're going to focus on the long-run
now, and then we're going to think about what
actually might happen in the short-run while we are
in fixed-price contracts, or we already have spent
money on something, or we have already, in
some ways, there are sticky things that can't adjust as quickly. But, we'll first focus on the long-run. On this axis, I'm just
going to plot price, and remember, we're thinking
in macro-economic terms. This is some measure of the prices of the goods and services in our economy. This axis right over here, the horizontal axis is
going to be real GDP. Once again, this is just
a model, you should take everything in economics
with a huge grain of salt. These are over-simplifications
of a highly, highly complex thing, the economy. Millions and millions of actors doing complex things, human
beings, each of them and their brain have billions
and billions and billions of neurons, doing all sorts
of unpredictable things. But economists like to make really simplifying,
super-simplifying assumptions, so that we can deal with
it in a attractable way, and in a even dealing
in a mathematical way. The assumtion that economists often make when we think about aggregate supply and aggregate demand is, in the long-run, real GDP actually does
not depend on prices in the long-run; so, what you have is, regardless of what the
price is, you're going to have the same real GDP. You can view this as a natural level of productivity for the economy. This is some level right over here. It's important to realize this is just a snap shot in time, and this
is all else things equal, so we're not assuming that
we're having changes in productivity overtime;
this is just a snap shot if we did have any of those
things that change. For example, if the population
increased, then that would cause this level to
shift to the right, then we would have a higher
natural level of productivity. If, for whatever reason, we
were able to create tools so that it was easier to
find people jobs, there's always a natural rate of unemployment. There's frictions, people
have to look for jobs, some people have to retrain
to get their skills, but maybe we improve
that in some way so that there's some website
where people can find jobs easier, or easier ways to train for jobs, and the natural level of
unemployment goes down, more people can produce, that would also shift this curve to the right. You could have a reality where there's technological improvements
that would also, and then all of a sudden, on an average, people would become more productive; that could shift things to the right. You could have discovery
of natural resources, new land that is super
fertile, and everything else; that could also shift things to the right. You could have a war, and maybe your factories get bombed, or
bad things happen in a war, especially if the war is on your soil, and that could actually
shift things to the left. So, it's important to realize
that this is just taking a snap shot in time, and a lot of these other things that we
think about would just shift it in 1 direction or another. I'm going to leave you
there, and this is a kind of it might not seem
intuitive at first, because you're saying, "Wait, look,
if prices were to change dramatically, if all of a
sudden everything in the economy got twice as
expensive, that would have some impact on peoples'
minds and that they would behave differently and all
the rest, and that might affect how much they can produce." We did think a little
about that when we thought about aggregate demand, but when we think about aggregate supply,
we're just thinking about their capability to produce. We're saying all else equal. We're saying that peoples'
mind-shifts aren't changing, their willingness
to work isn't changing, nothing else is changing,
technology isn't changing. Given that, price really
is just a numeric thing. If you just looked at the resources and the productive
capability of a country, the factors of production,
the people and all the rest, regardless of what the
prices are, they in theory, should be able to produce the same level of goods and services.