Macroeconomics For Dummies®, uk edition Published by: John Wiley & Sons, Ltd

Looking at Long-Run Aggregate Supply


Economists distinguish between the short run and the long run because the economy behaves in a different way depending on the time frame you’re looking at. The important thing about the long run is that prices are fully flexible (they can change a lot), whereas in the short run prices are sticky (in the sense that they don’t change by very much; check out the later section ‘Pulling apart why prices can be sticky’ for some suggested causes for this stickiness).

In this section we look at aggregate supply in the long run, which is more succinctly called long-run aggregate supply (LRAS).

Deciding on output in the long run

In the long run, two things determine aggregate supply (the total output that firms supply):

Available factors of production: Such as land, labour and capital.


Available technology: So that firms can convert factors of production into goods and services that households, firms and the government want to buy.


Factors of production: Inputs


Factors of production are the basic inputs that firms need to use in order to produce outputs (goods and services) that households, other firms and the government want to buy. Here are the three classic examples of factors of production:


Land: If you want to produce something, one of the first things you need is a place where the production can take place. Whether it’s a factory, an office or whatever, you need some place to put it! Furthermore, any raw materials that you’re going to use ultimately must come from the resources available on Earth – again from the land. Until humans colonise other planets, you can think about the total amount of land being fixed.


Labour: Firms need workers to supply their labour in order to help turn the inputs into outputs. Whether that’s operating the machines, talking on the phone to customers or sending emails to clients, all firms require workers and their labour to get things done. The more labour firms have available to them, the more they can produce. The total quantity of labour (in a country) can change: it can increase, for example, as a result of population growth or immigration; or it can decrease, for example, when demographic changes mean that more people are of retirement age.

Capital: Firms need machines, buildings, offices or some other kind of equipment that workers can use in order to produce things. The more capital firms have, the more output they can produce, all other things being equal. The amount of capital can increase or decrease over time: it can decrease due to depreciation, that is, the natural wear and tear that occurs over time; it can increase due to investment, in other words, the purchase (and creation) of new capital goods.

What economists mean by capital is different to the layperson’s usage. You can read more about the difference in Chapter 2.

In this chapter we focus on the two factors of production, labour (L) and capital (K) – we leave out land because it is easier to work with just two factors, and all of the points below apply equally to land. Yes, we know, capital begins with a C, not a K, but because economists use C to represent the level of consumption, the quantity of capital is called K!