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The Aggregate Production Function, the Market for Labor, and Long-Run Aggregate Supply

25 April, 2016 - 09:12

To derive the long-run aggregate supply curve, we bring together the model of the labor market, introduced in the first macro chapter and the aggregate production function.

As we learned, the labor market is in equilibrium at the natural level of employment. The demand and supply curves for labor intersect at the real wage at which the economy achieves its natural level of employment. We see in Panel (a) of Figure 23.6that the equilibrium real wage is ω1 and the natural level of employment is L1. Panel (b) shows that with employment of L1, the economy can produce a real GDP of YP. That output equals the economy’s potential output. It is that level of potential output that determines the position of the long-run aggregate supply curve in Panel (c).

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Figure 23.6 Deriving the Long-Run Aggregate Supply Curve

Panel (a) shows that the equilibrium real wage is ω1, and the natural level of employment is L1. Panel (b) shows that with employment of L1, the economy can produce a real GDP of YP. That output equals the economy’s potential output. It is at that level of potential output that we draw the long-run aggregate supply curve in Panel (c).