Question

Explain why the long run aggregate supply curve (LRAS) is vertical. Given that the LRAS curve constrains the long run growth potential of the economy, discuss what can be done to make it grow more quickly. Are there any examples of current policies (or proposed policies) trying to do just that?

Answer 1

The economists considered that the short run changes in aggregate demand were temporary in nature. This will not affect the overall price level. The price level does not affect the long run determinants of the real GDP, thus the aggregate supply curve is vertical in nature. The long run aggregate supply curve is a graphical representation of classical dichotomy and neutrality of money. These classical theory nominal variables will not affect the real variables. In long run the quantity of output is not depends on the level of process.
The policies which were imposed by the monetary authority will shift the aggregate supply curve in long run. These policies are indifferent towards the price level. A rightward shift in the aggregate supply curve shows a rise in output and vice versa. The supply side policies are government introduced policies which increase the productivity and increase efficiency of the economy. For example if the monetary authority increase the money supply. This will leads to the reduction of inflation and unemployment, improvement in the economic growth and trade balances. In long run this benefits will not affect the price level. The supply side policies are privatisation, deregulations, income tax cuts, removal of regulations, flexibility in the labour market, free trade agreements, reduction in the welfare benefits etc.