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LAW OF COMPARATIVE ADVANTAGE: A basic principle that states every nation has a production activity that incurs a lower opportunity cost than that of another nation, which means that trade between the two nations can be beneficial to both if each specializes in the production of a good with lower relative opportunity cost. While this law is fundamental to the study of international trade, it also applies to other activities, especially the specialization and the division of labor.

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AGGREGATE SUPPLY INCREASE, LONG-RUN AGGREGATE MARKET:

A shock to the long-run aggregate market caused by an increase in aggregate supply, resulting in and illustrated by a rightward shift of the long-run aggregate supply curve. An increase in aggregate supply in the long-run aggregate market results in a decrease in the price level and an increase in real production. The level of real production resulting from the shock is a greater level of full-employment real production.
While a wide range of specific aggregate supply determinants can cause an increase in aggregate supply, the following rank among the more important:
  • Growth of the population or an increase in the labor force participation rate, both of which increase the quantity of labor available for production.

  • Investment in capital goods prompted by lower interest rates, lower capital good prices, or technological advances, which increases the quantity of capital available for production.

  • The discovery of new mineral deposits or fossil fuels, both of which increase the quantity of land resources available for production.

  • An increase in education which increases the quality of labor resources.

  • An increase in technology which increases the quality of capital resources.
Supply Increase
Long-Run Aggregate Market
Long-Run Aggregate Market
The long-run aggregate market presented in this graph to the right sets the stage for analyzing the effect of an increase in aggregate supply resulting from a change in an aggregate supply determinant. The vertical axis measures the price level (GDP price deflator) and the horizontal axis measures real production (real GDP). The negatively-sloped curve, labeled AD, is the aggregate demand curve and the vertical curve, labeled LRAS, is the long-run aggregate supply curve. The current long-run equilibrium, found at the intersection of the AD and LRAS curves, is a price level of 10 and real production of $100 billion. This equilibrium level of real production is also full-employment real production.

Consider what happens to this long-run aggregate market with an increase in aggregate supply. Suppose, for example, that changing customs and attitudes lead to an increase in the female labor force participation rate. This increases the total quantity of labor available for production. The result of this is a rightward shift of the LRAS curve. Click the [LRAS Increase] button to illustrate.

The result of this rightward LRAS curve shift is that a new long-run equilibrium is achieved at a lower price level (8) and a larger amount of full-employment real production ($120 billion). This result is comparable to that for a standard market. An increase in market supply results in a lower equilibrium price and a larger equilibrium quantity. The key difference, of course, is that this "market" is the aggregate product market for the entire economy and not the market for a specific good.

A comparative static analysis of the original equilibrium and the new equilibrium is useful and important. However, it is also instructive to dissect the adjustment process.

  • First, the LRAS curve shifts rightward due to the increase in the quantity of labor induced by the increase in the female labor force participation rate. This "extra" aggregate supply creates an imbalance in the aggregate market. At the existing price level (which has NOT yet changed), buyers are willing and able to buy only $100 billion worth of real production. Producers, however, are now willing and able to sell $120 billion worth of real production. This creates economy-wide product market surpluses.

  • Second, motivated by a build-up of inventories created by economy-wide product market surpluses, producers try to decrease production. In the short run they can do so by reducing the employment of resources, especially labor. In the long run, however, wage and resource price flexibility ensures that any imbalances in the resource markets are eliminated. Resource markets remain in equilibrium, meaning full-employment production is supplied. The only long-run result of attempts by producers to decrease production is a falling price level.

  • Third, with the falling price level, buyers are induced to increase aggregate expenditures. The increase in aggregate expenditures acts to reduce the economy-wide product market surpluses. In fact, as long as these surpluses persist, the price level falls and aggregate expenditures rise. This continues until aggregate expenditures exactly match the new full-employment level of production. The end result is a new long-run equilibrium price level of 8 and an a new full-employment real production level of $120 billion.

<= AGGREGATE SUPPLY DETERMINANTSAGGREGATE SUPPLY INCREASE, SHORT-RUN AGGREGATE MARKET =>


Recommended Citation:

AGGREGATE SUPPLY INCREASE, LONG-RUN AGGREGATE MARKET, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2021. [Accessed: August 4, 2021].


Check Out These Related Terms...

     | aggregate market shocks | aggregate demand decrease, long-run aggregate market | aggregate demand increase, long-run aggregate market | aggregate supply decrease, long-run aggregate market | aggregate demand increase, short-run aggregate market | aggregate demand decrease, short-run aggregate market | aggregate supply increase, short-run aggregate market | aggregate supply decrease, short-run aggregate market |


Or For A Little Background...

     | aggregate market | aggregate market analysis | long-run aggregate market | equilibrium, aggregate market | equilibrium, long-run aggregate market | aggregate demand | aggregate supply | aggregate expenditures | long-run aggregate supply | aggregate demand curve | long-run aggregate supply curve | price level | GDP price deflator | real gross domestic product | market adjustment | supply shock |


And For Further Study...

     | disequilibrium, aggregate market | disequilibrium, long-run aggregate market | output gaps | self correction, aggregate market | self correction, recessionary gap | self correction, inflationary gap | Keynesian economics | monetary economics | classical economics |


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