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A vertical as curve

The graph shows a straight vertical potential GDP line.
In the neoclassical model, the aggregate supply curve is drawn as a vertical line at the level of potential GDP. If AS is vertical, then it determines the level of real output, no matter where the aggregate demand curve is drawn. Over time, the LRAS curve shifts to the right as productivity increases and potential GDP expands.

The role of flexible prices

How does the macroeconomy adjust back to its level of potential GDP in the long run? What if aggregate demand increases or decreases? The neoclassical view of how the macroeconomy adjusts is based on the insight that even if wages and prices are “sticky”, or slow to change, in the short run, they are flexible over time. To understand this better, let's follow the connections from the short-run to the long-run macroeconomic equilibrium.

The aggregate demand and aggregate supply diagram shown in [link] shows two aggregate supply curves. The original upward sloping aggregate supply curve (SRAS 0 ) is a short-run or Keynesian AS curve. The vertical aggregate supply curve (LRASn) is the long-run or neoclassical AS curve, which is located at potential GDP. The original aggregate demand curve, labeled AD 0 , is drawn so that the original equilibrium occurs at point E 0 , at which point the economy is producing at its potential GDP.

The rebound to potential gdp after ad increases

The graph shows two aggregate demand curves and two aggregate supply curves that all intersect with the Potential GDP line at 50 on the x-axis. AD1 intersects with AS1 at point (130, 50). AD0 and AS0 intersect at point (120, 50). Additionally, AD1 intersects with AS0 at (125, 55).
The original equilibrium (E 0 ), at an output level of 500 and a price level of 120, happens at the intersection of the aggregate demand curve (AD 0 ) and the short-run aggregate supply curve (SRAS 0 ). The output at E 0 is equal to potential GDP. Aggregate demand shifts right from AD 0 to AD 1 . The new equilibrium is E 1 , with a higher output level of 550 and an increase in the price level to 125. With unemployment rates unsustainably low, wages are bid up by eager employers, which shifts short-run aggregate supply to the left, from SRAS 0 to SRAS 1 . The new equilibrium (E 2 ) is at the same original level of output, 500, but at a higher price level of 130. Thus, the long-run aggregate supply curve (LRASn), which is vertical at the level of potential GDP, determines the level of real GDP in this economy in the long run.

Now, imagine that some economic event boosts aggregate demand: perhaps a surge of export sales or a rise in business confidence that leads to more investment, perhaps a policy decision like higher government spending, or perhaps a tax cut that leads to additional aggregate demand. The short-run Keynesian analysis is that the rise in aggregate demand will shift the aggregate demand curve out to the right, from AD 0 to AD 1 , leading to a new equilibrium at point E 1 with higher output, lower unemployment, and pressure for an inflationary rise in the price level.

In the long-run neoclassical analysis, however, the chain of economic events is just beginning. As economic output rises above potential GDP, the level of unemployment falls. The economy is now above full employment and there is a shortage of labor. Eager employers are trying to bid workers away from other companies and to encourage their current workers to exert more effort and to put in longer hours. This high demand for labor will drive up wages. Most workers have their salaries reviewed only once or twice a year, and so it will take time before the higher wages filter through the economy. As wages do rise, it will mean a leftward shift in the short-run Keynesian aggregate supply curve back to SRAS 1 , because the price of a major input to production has increased. The economy moves to a new equilibrium (E 2 ). The new equilibrium has the same level of real GDP as did the original equilibrium (E 0 ), but there has been an inflationary increase in the price level.

Questions & Answers

what the word federal mean
Kabba Reply
Meaning of "movement along curve?
Lizabeth Reply
There is movement along curve whenever the 'price' is affected
Isha
its mean price is positively response as demand change and price is negatively reaponse as supply changes
Mudasir
its mean when quantity demanded of commodity changes due to a change in its price ,keeping other factors constant, it is know as change in quantity demanded.
Gyamfua
pleas wat the formula when calculating for equilibrium point
Irene
when there is increase in the price
sautil
when there is increase in demand, demand will decrease.
Shadrick
A movement along curve is a movement on the curve mainly caused by a change occured in both quantity demand and quantity supplied.
Aarohi
what is demand
Dennis Reply
unwilling to buy good quality at a particular price and a particular time
Musa
Demand is the willingness and ability to buy goods and services at different prices at a given time.
Aarohi
is production function different from psychological law of consumption?
Kshirodra Reply
why supply is not the same quantity supplied
emmanuel Reply
What is Elasticity?
Kamara
I don't even understand
Awuah
what is damand
Cletus
Elasticity is an economic concept used to measure the change in the aggregate quantity demand for a goods or service in relation to price movements of that goods and service.
Gyamfua
Demand is an economic principal referring of a consumers desire to purchase goods and service and willingness to pay a price for a specific goods or service.
Gyamfua
supply is not the same as quantity supplied, because when economic refer to supply, they mean the relationship between a range of price an the quantity supplied those price -are relationship that can be illustrated with a supply curve or supply schedule
Gyamfua
Is a science which study human behavior as a relationship between ends and scares means which have alternative uses
BOOMBA Reply
I dont think so
Mahmood
It is Economic growth and stability
Mahmood
How Economic recovery growth Planning
Mahmood Reply
Expatiate your question
Awuah
Yh
Berry
Are bonds the same as liabilities?
Anderson Reply
Demend create it own supply how?
Mahmood
what is way ofrece thinking
Mahmood
what is the Economic way thinkig?
Mahmood
what is gasoline
Deepak Reply
how to know which products demand
Deepak
in other words economic can be define as what?
Ojarigho Reply
what is the difference between economics activities and economics system
Joshua Reply
what is the difference between price elasticity of demand and income elasticity of demand
Ellen Reply
what is demand
Alpha Reply
What is demand
Musa
is a measure of responsiveness at which a consumer is willing and able to offer a particular product at a given period of time
Manu
what is consumer
chill Reply
what is economics?
Odei Reply

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Source:  OpenStax, Principles of economics. OpenStax CNX. Sep 19, 2014 Download for free at http://legacy.cnx.org/content/col11613/1.11
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