Question

1. What is the significance of considering LRAS & SAS in the Macro S & D model?

Answer 1

Ans. Supply curve is different in both short run and in long run. In short run, the wage contracts are sticky, so, increase in price level in the economy leads decrease in real wages of the employees because of sticky wages which decreases the cost of production of goods and services. This encourages production units to increase production increasing the aggregate supply. Similarly, decrease in price level increases real wages of the employees due to sticky wages. So, cost of production increases decreasing aggregate supply of goods and services. Thus, in short run aggregate supply is upward sloping because price and aggregate supply are directly related.

In long run, wages are not sticky i.e. they can be increased or decreased. So, when price level increases real wages fall due to which employees demand higher wages increasing cost of production , so, increase in price does not increase aggregate supply. Similarly, aggregate supply does not change when price level decreases. Thus, long run aggregate supply curve is vertical because aggregate supply is independent of the price level.

Thus, both SAS and LRAS are significant as relation between price and aggregate demand changes from short run to long run.

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