2.3.3 Long-Run Aggregate Supply

Question 1

Define Long-Run Aggregate Supply

Answer 1

The long-run aggregate supply (AS) curve represents the relationship between the total quantity of goods and services that firms in an economy are willing to produce and the price level, assuming that all prices, including nominal wages, are flexible.

Question 2

Explain the shape of the Keynesian LRAS curve (in three segments)

Answer 2

1. Horizontal Segment: At low levels of output and employment, the curve is horizontal. 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, indicating that output is at its maximum sustainable level, and any further demand increase will only lead to higher prices.

Question 3

What are the key beliefs of the Keynesian LRAS curve?

Answer 3

Key Insights:
Emphasizes 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.
Real-World Example: The Great Depression of the 1930s. High unemployment and unused capacity meant that increased government spending could boost output without causing inflation.

Question 4

Describe the shape of the classical AS curve
Also outline the key beliefs behind it

Answer 4

Shape: The Classical AS curve is vertical at the full-employment level of output.
Reflects the belief that in the long run, the economy is always at full employment due to the flexibility of prices and wages.
Output is determined by factors such as technology, resources, and institutional structures, not by the price level.
Key Insights:
Assumes that markets clear and that supply creates its own demand (Say’s Law).
Long-term output is not affected by changes in the price level.
Suggests that any government intervention is unnecessary and potentially harmful, as the economy self-adjusts to full employment.

Question 5

Who are the key economists for each school of thinking?

Answer 5

Keynesian:
John Maynard Keynes (1883-1946):
Advocated for government intervention to manage economic cycles.
Key work: “The General Theory of Employment, Interest and Money” (1936).
Introduced concepts such as aggregate demand and the Keynesian AS curve.

Classical Economists:
Adam Smith (1723-1790):
Known as the father of modern economics.
Key work: “An Inquiry into the Nature and Causes of the Wealth of Nations” (1776).
David Ricardo (1772-1823):
Developed the theory of comparative advantage.
Key work: “Principles of Political Economy and Taxation” (1817).

Question 6

What are some Key Factors Influencing Long-Run AS?

Answer 6

Technological Advances
Impact: Technological improvements increase productivity, allowing more output from the same input of labor and capital.
Examples:
The Industrial Revolution, which introduced machinery that enhanced production processes.
Modern-day advancements in information technology, which have streamlined communication and data management, boosting productivity across sectors.
Changes in Relative Productivity
Impact: Increases in productivity in one sector relative to others can shift resources, optimizing the overall efficiency of the economy.
Examples:
The shift from manufacturing to service-oriented industries in advanced economies, driven by higher productivity in technology and finance sectors.
Agricultural productivity improvements in developing countries, freeing labor for industrial and service sectors.
Changes in Education and Skills
Impact: A more educated and skilled workforce can produce more output and adapt to new technologies, enhancing long-run AS.
Examples:
Investments in STEM (Science, Technology, Engineering, and Mathematics) education leading to a more innovative workforce in countries like South Korea.
Vocational training programs in Germany that equip workers with specialized skills, increasing productivity.
Changes in Government Regulations
Impact: Regulations can either constrain or enhance productivity. Deregulation can lead to increased efficiency, while excessive regulation can stifle innovation and growth.
Examples:
Deregulation of the airline industry in the United States in the late 1970s, which increased competition and efficiency.
Stringent environmental regulations in the European Union that, while protecting the environment, may increase production costs in certain industries.
Demographic Changes and Migration
Impact: Population growth, aging, and migration patterns significantly affect the labor supply and thus long-run AS.
Examples:
Japan’s aging population leading to a shrinking workforce and lower potential output.
Migration influxes in the United States and Germany, contributing to a growing labor force and economic expansion.
Competition Policy
Impact: Policies that promote competition can lead to more efficient markets and higher productivity.
Examples:
Antitrust laws in the United States that prevent monopolies and promote competitive markets.
The European Union’s policies to reduce barriers to entry in various industries, fostering innovation and efficiency.