Th2.4: Long Term - Classical LRAS Flashcards
As the classical LRAS curve is perfectly inelastic…
a shift of the AD curve would not affect long run national output and would only affect price levels
Why do classical economists believe there will be no unemployment in the long run?
believe the economy will always return to full employment level
Refer to PP
Look at Graph 3. What do classical economists believe will make a positive output gap?
an increase of AD from AD1 to AD2
Refer to PP
Look at Graph 3. Why is the economy in long term disequilibrium?
SRAS1 and AD2 do not intersect on the LRAS curve
Refer to PP
Look at Graph 3. Where is the short term equilibrium? What does this mean?
P2Y2
there is over-full employment and firms will end up bidding up wages of labour (as each offers higher salaries to attract the best workers) and the other factor prices
Why does SRAS shift to SRAS2?
the cost of production has increased
Refer to PP
Look at Graph 3. Eventually the economy is producing at Y1P3, meaning…
the economy is producing the same amount but now at higher prices
What do classicists conclude?
that an increase in AD will increase price and output in the short run but over time, prices will continue to rise as the economy moves back to the long-term equilibrium - output has not changed and the only way to increase output is by increasing the LRAS
Therefore, what is the only way to increase output here?
by increasing the LRAS
Changes in AD without a change in the LRAS are…
only inflationary
Refer to PP
Look at Graph 4. What has the increase from LRAS1 to LRAS2 caused?
lower prices and higher output, at P2Y2
Refer to PP
Look at Graph 4. Although there is short term disequilibrium…
they believe this will be closed by a shift in SRAS
What is a rise in the long run aggregate supply likely to lead to?
lower prices and higher output
When is it easy to understand why classicists favour supply-side policies over demand management?
when Graph 4 is compared with a shift in AD which increases prices and delivers no higher output
