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The LRAS is shown as perfectly vertical, reflecting economists' belief that changes in aggregate demand (AD) have an only temporary change on the economy's total output. Medium run aggregate supply (MRAS) — As an interim between SRAS and LRAS, the MRAS form slopes upward and reflects when capital, as well as labor usage, can change. More ...
A vertical long-run aggregate supply curve (sometimes called a "classical" aggregate supply curve) illustrates a situation where the level of output does not depend on the price level, but is exclusively determined by the supply of production factors like the capital and the labour force, employment being at its structural ("natural") level.
The Keynesian cross diagram is a formulation of the central ideas in Keynes' General Theory of Employment, Interest and Money.It first appeared as a central component of macroeconomic theory as it was taught by Paul Samuelson in his textbook, Economics: An Introductory Analysis.
In most mathematical contexts, the independent variable is placed on the horizontal axis and the dependent variable on the vertical axis. For example, if f(x) is plotted against x, conventionally x is plotted horizontally and the value of the function is plotted vertically. This placement is often, but not always, reversed in economic graphs.
In neoclassical macroeconomics, the highest sustainable level of aggregate real GDP or "potential" is seen as corresponding to a vertical LRAS curve: any increase in the demand for real GDP can only lead to rising prices in the long run, while any increase in output is temporary.
In this case, the LM curve becomes horizontal at the interest rate level chosen by the central bank, allowing a simpler kind of dynamics. Also, the interest rate level measured along the vertical axis may be interpreted as either the nominal or the real interest rate, in the latter case allowing inflation to enter the IS–LM model in a simple way.
In the diagram, the long-run Phillips curve is the vertical red line. The NAIRU theory says that when unemployment is at the rate defined by this line, inflation will be stable. However, in the short-run policymakers will face an inflation-unemployment rate trade-off marked by the "Initial Short-Run Phillips Curve" in the graph.
Observing these similarities yet seemingly non-deterministic fluctuations about trend, the question arises as to why any of this occurs. Since people prefer economic booms over recessions, it follows that if all people in the economy make optimal decisions, these fluctuations are caused by something outside the decision-making process.