Long-Run Aggregate Supply
refers to the output an economy can produce using all the resources and technology that it has available. This takes into account the full employment of the labor force.
Long-Run Aggregate Supply Details
Long-run aggregate supply, LRAS for short, is a theoretical concept in economics and finance. Graphically it is expressed as a vertical curve. The vertical nature of the curve points to the fact that output is not affected by changes in the price level.
Producers typically respond to changes in the price level of factors of production in the short run. This could be an increase in the prices of raw materials or labor costs. Hence, a mutually exclusive relationship between output and price level is only possible in the long run. We can easily understand the term "long-run" as a sufficient period of time for nominal wages and other input prices to change when the price level changes.
There is no defined expanse of time that constitutes the long run, giving room for as little or as much time as is required for prices to adjust fully. Since prices are fully adjusted in the long run, the corresponding output value of the LARS reflects the economy's true potential.
Example of Long-Run Aggregate Supply
The long-run concept often seems vague, keeping producers at a loss for when the long run actually is. The illustration below, although arbitrary, should buttress this point:
Imagine making a trip to the petrol station and finding that the price of diesel has nearly doubled. If the need is urgent, you could make the purchase, although with much dismay. With the knowledge of this price change, a rational thought for the average individual on a budget would be to find an alternative. You may opt for taking public transportation in the meantime or carpooling to share costs.
However, if the prices stay high for long enough, at some point, you'll no longer be bothered by the high prices. You would begin purchasing diesel at the increased price as if it were normal. Essentially, when you no longer react to the price change or make decisions based on it, it's safe to say that prices have adjusted. If prices haven't adjusted yet, then it's not the long run.
Long-Run Aggregate Supply vs. Short-Run Aggregate Supply
The relationship between the price level and production (Aggregate supply) is often considered in two time frames: the short and long run. The Short-Run Aggregate Supply, abbreviated as SRAS, is simply the converse of the LRAS.
A major difference is that short-run prices are fixed, while long-run prices are flexible. We've established that with enough time, prices will adjust. However, the real-time market situation will reflect stipulated prices often determined by manufacturers and influenced by demand and other factors. Other contrasts between LARS and SRAS are:
- The SRAS curve is an upward slope; the LRAS curve is vertical
- SRAS assumes that expansion isn't feasible as the level of capital is fixed; the variable capital in LRAS supports expansion.
- An increase in sales price encourages an increase in production in the short run; production levels are unaffected by sales prices in the long run.