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Aggregate Demand changes with neoclassical LRAS

Many economists argue that the LRAS curve is vertical, which means that any increase in AD will only lead to an increase in prices (in the long run remember).

A time lag exists between the level of demand increasing and the supply sector of the economy being able to expand to meet this. Therefore only increases in LRAS will allow rises in AD to be met without inflationary pressures. Demand Management policies then do not work in the long run.

Supply-side policies enable the economy to expand in a non-inflationary way, as shown in Figure 1 below.


Figure 1 Impact of supply-side policies

If AD1 shifts to AD2 (eg Fiscal Policy) then prices will rise (inflationary pressure) unless LRAS1 also shifts to LRAS2.