Short-Run Aggregate Supply slopes up because some costs are sticky. Given enough time, though, wages and other costs catch up with prices. Then the economy's output depends only on what it can produce, as on the production possibilities curve, with unemployment at its natural rate.
Key idea
Long-run aggregate supply (LRAS) is a vertical line at full-employment (potential) output. It shifts only when the economy's capacity changes: more or better resources (labor, capital, land), better technology, or better institutions.
Why it works
Suppose all prices and all wages double. Each worker's pay buys the same as before, each firm's profit per unit is the same in real terms, so no one has a reason to work or produce more. Real output stays where resources and technology put it. That is why LRAS is vertical: in the long run the price level does not change real output. Producing on LRAS matches producing on the PPC; a recessionary gap is like a point inside the curve, and growth shifts both outward.
Worked examples
Worked example: What shifts LRAS?
Which shift LRAS? (a) A wave of new factories and machines. (b) The price level rises 10%. (c) Government purchases rise.
- (a) More capital raises potential output: LRAS shifts right.
- (b) The price level does not change capacity: no shift.
- (c) More spending shifts AD, not capacity: no LRAS shift.
Answer: Only (a)
Worked example: Where output ends up
Potential output is \$20 trillion. Demand rises and output briefly reaches \$21 trillion. Where is output in the long run?
- Wages and costs catch up, SRAS shifts left, and output returns to LRAS.
- Long-run output is \$20 trillion, at a higher price level.
Answer: \$20 trillion
Common mistake
Drawing LRAS sloping up, or shifting it when demand changes. LRAS moves only when the economy's capacity to produce changes. Check: ask "does this change the resources, technology or institutions the economy has?"