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Chapter 24: Problem 1

Explain why the long-run aggregate supply curve is vertical.

Short Answer

Expert verified
The long-run aggregate supply curve is vertical because in the long run, the quantity of goods and services that firms are willing to produce remains constant at the economy's potential level of output, regardless of the overall price level. This is because, in the long run, all prices are fully flexible, and the economy reaches an equilibrium state of full employment where unemployment equals the natural rate of unemployment.

Step by step solution

01

Understand the concept of the LRAS curve

The long-run aggregate supply curve is a graphic representation that shows the relationship between the price levels and the quantity of output that firms are willing and able to supply. It represents the final stage after all economic adjustments have played out and is based on the premise of 'full flexibility of prices', meaning the economy has adequately adjusted to any demand and supply changes.
02

Identify Full-employment Real GDP

The long-run supply is determined by the productive resources that the economy has such as labor, capital, technology, and institutional arrangements. It corresponds to the real GDP at full employment meaning unemployment is equal to the natural rate of unemployment. In the long run, the economy reaches this state of equilibrium.
03

Explaining Vertical Nature of LRAS curve

In the long run, it is assumed that the economy's productive resources and technology do not change. Therefore, the amount of goods and services that firms are willing and able to produce - the real GDP - remains constant regardless of the overall price level. This infers that the LRAS curve is vertical. Any change in the price level does not alter the output that firms wish to supply in the long run.

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Most popular questions from this chapter

What variables cause the short-run aggregate supply curve to shift? For each variable, identify whether an increase in that variable will cause the short- run aggregate supply curve to shift to the right or to the left.

In 2017, an editorial on bloomberg.com was titled "Canada Must Deflate Its Housing Bubble." What does the editorial mean by the "housing bubble"? Why should government policymakers be worried about a housing bubble?

A student is asked to draw an aggregate demand and aggregate supply graph to illustrate the effect of an increase in aggregate supply. The student draws the following graph: The student explains the graph as follows: An increase in aggregate supply causes a shift from \(\operatorname{SRAS}_{1}\) to \(S R A S_{2}\). Because this shift in the aggregate supply curve results in a lower price level, consumption, investment, and net exports will increase. This change causes the aggregate demand curve to shift to the right, from \(\mathrm{AD}_{1}\) to \(\mathrm{AD}_{2}\). We know that real GDP will increase, but we can't be sure whether the price level will rise or fall because that depends on whether the aggregate supply curve or the aggregate demand curve has shifted farther to the right. I assume that aggregate supply shifts out farther than aggregate demand, so I show the final price level, \(P_{3}\), as being lower than the initial price level, \(P_{1}\). Explain whether you agree with the student's analysis. Be careful to explain exactly what - if anything-you find wrong with this analysis.

An article in the Economist discussing the \(2007-2009\) recession stated that "employers found it difficult to reduce the cash value of the wages paid to their staff. (Foisting a pay cut on your entire workforce hardly boosts morale.)" a. During a recession, couldn't firms reduce their labor costs by the same, or possibly more, if they laid off fewer workers while cutting wages? Why did few firms use this approach? b. What does the article mean by firms reducing the "cash value" of workers' wages? Is it possible for firms to reduce workers' wages over time without reducing their cash value? Briefly explain.

If real GDP in the United States declined by more during the \(2007-\) 2009 recession than did real GDP in Canada, China, and other trading partners of the United States, would the effect be to increase or decrease U.S. net exports? Briefly explain.
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