Changing Aggregate Supply

In the examples so far, we have had changing Aggregate Demand with unchanging Long-Run Aggregate Supply. But Long Run Aggregate Supply can change, and has certainly changed a great deal over history. Long Run Aggregate Supply depends on four things:

The population: First, an increase in the population will mean that there are more people to do the work; that means that more can be produced without speeding up inflation.
The Rate of Labor Force Participation: The Rate of Labor Force Participation, a fraction, is the proportion of the population who supply labor. The higher the Rate of Labor Force Participation, the more can be produced without speeding up inflation, ceteris paribus.
The NAIRU: The NAIRU, by its definition, is the smallest unemployment rate that can coexist with non-accelerating inflation. The higher the NAIRU, the fewer workers are employed at the NAIRGDP, and the less is produced.
The Average Productivity of Labor: To determine the NAIRGDP, multiply the population by the Rate of Labor Force Participation to get the work force, multiply that by one minus the NAIRU to get the employed labor force, and multiply that by the Average Productivity of Labor to get the NAIRGDP.

All of the four determinants of Long Run Aggregate Supply can change over time. We have discussed changes in the population and in labor productivity in more detail in the chapter on economic growth. One thing we know is that, from decade to decade, population and productivity have gradually increased, shifting the Long Run Aggregate Supply Curve gradually to the right. Let's see what that looks like in an AS/AD diagram.

Deflationary Growth