Long-Run Aggregate Supply Curve
The long-run aggregate supply curve shows the quantity of goods and services that firms offer at each price level in the long run. It is vertical because, in the long run, the price level does not affect the level of output, unlike the aggregate demand curve, which always has a downward slope. The slope of the aggregate supply curve depends on the time horizon.
Graph of the Long-Run Aggregate Supply Curve
In the long run, the price level does not affect the total production of goods and services in the economy; in other words, in the long run, the price level does not affect real GDP or its determinants. The price level over a long time horizon does not affect the supplies of labor, capital, natural resources, nor does it impact the technology available to convert production factors into goods and services. For this reason, the long-run aggregate supply curve is vertical.
In the graph, when the price level decreases from P1 to P2, the level of aggregate supply Y remains the same; consequently, the only thing that changes is the price level and not the aggregate output. The opposite occurs with the short-run aggregate supply curve, which has a positive slope, and therefore, a change in the price level affects the level of production.
The vertical long-run aggregate supply curve is consistent with the idea that nominal variables do not affect real ones; that is, the classical dichotomy is satisfied because changes in the price level (nominal variable) do not affect the level of output (real variable).
Determinants of the Long-Run Aggregate Supply Curve
Classical macroeconomic theory, or long-run theory, explains the behavior of the economy in the long run; therefore, we can use this theory to explain the long-run aggregate supply curve. The level of output depends on fixed amounts of capital and labor, and the available technology, as shown by the following function:
The equation that represents total production in the economy is expressed as:
\[ Y = F(\overrightarrow{K}, \overrightarrow{L}) \]
In this equation:
- Y: Represents total output or the level of product in the economy.
- F: Is a production function that shows the relationship between inputs and output.
- \(\overrightarrow{K}\): Represents capital, considered fixed in the short run.
- \(\overrightarrow{L}\): Represents labor, also fixed in the short run.
In the short run, \(\overrightarrow{K}\) and \(\overrightarrow{L}\) are constants, which limits total production to the available capacity of capital and labor, and the current technology.
The production function \(F(\overrightarrow{K}, \overrightarrow{L})\) illustrates how these inputs generate the level of output in the long run. The long-run aggregate supply curve is vertical, indicating that, in the long run, the level of output in the economy is determined by the amount of resources and technology, not by the price level. Therefore, changes in the price level do not affect the output in the long run, as firms adjust their production to optimal capacity.
In other words, if there were two identical economies with the same level of capital, labor, and technology, their aggregate supply would be the same in the long run, even if the money supply and price level were higher in one than in the other, because in the long run, the price level does not affect the determinants of real GDP.
Conclusion
The fact that the long-run aggregate supply curve is vertical shows that production is fixed at that level, regardless of the price level, since in the long run, the level of output is determined by the level of capital, labor, and the available technology, and it does not depend on the price level.