2.3 - Long-run aggregate supply Flashcards
Aggregate supply
What is long-run aggregate supply influenced by?
- A change in the productive capacity of the economy
> productive capacity is changed by changes to the quantity or quality of the factors of production
Classical LRAS curve
- LRAS is perfectly inelastic (vertical) as it is independent of the price level and is determined by the quantity and quality of all factors of production
- The LRAS is a perfectly inelastic at a point of full employment of all available resources
- This point corresponds to the maximum possible output on a PPF
- It shows the productive potential of the economy/ the full capacity output
i.e. where all resources are being fully utilised
How does the classical view believe the economy will self correct?
- The classical view believes the economy will always return to the full employment level of real national output in the long-run, but at a different average price level.
- This is because markets tend to correct themselves fairly quickly.
- This means although an economy can be in disequilibrium at any moment in time it will naturally move towards equilibrium position where all resources are employed and the economy is producing at its productive potential; on its PPF.
- This means LRAS is vertical.
Why is it possible for an economy to exceed the maximum potential LRAS in the short run but not in the short run?
- By allowing factors of production to work overtime or not allow time for maintenance of machinery etc.
- However, this is not possible in the long run as
machines will eventually stop and workers will want a break.
Inflationary gap
The amount by which the actual level of national output (Real GDP) exceeds potential output
Recessionary gap
The amount by which the actual level of national output (Real GDP) is less than the potential output
There may be short-run output gaps in the economy.
> Describe the two that may occur
- During extreme periods of economic growth,
- there may be an inflationary gap that develops.
> In the long run this will self-correct and return to the long-run level of output, but at a higher average price level. - During slowdowns / recessions,
- there can be a recessionary gap that develops
> In the long-run this will self-correct and return to the long-run level of output but at a lower average price level.
Keynesian LRAS curve
- Shape: The Keynesian AS curve is typically depicted as a backward-L shape.
> Horizontal Segment: At low levels of output and employment, the curve is horizontal - perfectly elastic
This indicates that firms can increase production without raising prices due to unused capacity and high unemployment.
> Upward Sloping Segment: As the economy approaches full employment, the curve starts to slope upwards, reflecting increasing pressure on wages and prices.
> Vertical Segment: At full employment, the curve becomes vertical -perfectly inelastic
indicating that output is at its maximum sustainable level, as all available resources are employed
and any further demand increase will only lead to higher prices/inflation (resources become scarce so firms have to increase prices to cope supply more)
Keynesian theory of LRAS insights
- Emphasises the existence of unemployment and idle capacity in the economy.
- Suggests that in the short run, output can be increased without causing inflation until full employment is reached.
- Government intervention, such as fiscal policy, can help achieve full employment without causing inflation in the short run.
Factors influencing long-run AS
- technological advances
- changes in relative productivity
- changes in education and skills
- changes in government regulations
- demographic changes and migration
- competition policy
Explain how technological advances can influence LRAS
- Technological advances often improve the quality of the factors of production
- so they cause production to speed up, so more goods can be produced with the same amount of resources.
- this increases the LRAS as it means that more goods can be produced
- LRAS shifts right
Explain how changes in relative productivity can influence LRAS
- The more productive the economy is, the
more that will be produced with the given resources. - Productivity depends on a range of factors, such as efficiency, skill of labour and technology.
- So if productivity increases, productive capacity increases
- LRAS shifts right
Explain how changes in education and skills can influence LRAS
- A more skilled workforce will be more employable and work quicker and more efficiently within their jobs, so the output per worker will increase,
- Education could also be
used to improve the occupational mobility of labour which decreases structural unemployment as people are able to switch to new jobs. This will ensure all
resources are used efficiently
> These will shift the LRAS to the right as the quality of labour has improved
Explain how changes in government regulations can influence LRAS
- Changes in government regulation can increase the quantity of the factors of production in an economy, Eg by:
- increasing the size of the workforce.
> can do this is by
encouraging people to go back to work and decreasing the level of inactivity.
> parents can be enticed back to work by free childcare at pre-school.
> Unemployment can be decreased by reducing benefits, which will
encourage those living off benefits to find jobs.
> could lower corporate tax so firms production costs are lowered - more profits - can employ more workers - increase output and LRAS
> can change
the working age which will expand the workforce as more people are able to
work.
- Increasing the workforce will shift LRAS right because it means there are more resources in the economy and so more can be produced. - Government policy can increase research and development if they offer tax breaks to businesses who invest money into r&d
> This will lead to innovation, improving the quality/quantity of factors of production causing an increase in the LRAS as it will improve productivity. - LRAS shifts right - Deregulation
> high regulation on businesses will limit LRAS as it will increase
costs and the time taken to undertake tasks, which will reduce output.
Explain how demographic changes and migration can influence LRAS
- A positive net birth rate or positive net migration rate will increase quantity of labour available
- This will increase LRAS as productivity has increased - shifts right
> However:
- The value and importance immigration will depend on the
age and skill of immigrants
- In an ageing population or a young population,
LRAS will be lower as the working population is smaller so therefore less goods can
be produced.
- The more people who are of working age, the higher the LRAS.
Explain how changes in competition policy can influence LRAS
- The government can promote competition (preventing monopoly power) between businesses and markets which will force them to improve the quality of their goods or
lower prices. - In order for businesses to do this and still make a profit, they have to
improve their efficiency and this efficiency will mean that more goods and services
can be produced, - so LRAS will increase.
- However, less competition can sometimes be beneficial if it encourages investment and innovation.
For example, copyright laws mean that businesses’ new ideas can’t be copied which will encourage them to do
more research as they know they will be the ones who benefit in terms of higher profits.
