2.3.3 Long-run AS Flashcards
Long - run aggregate supply ( LRAS )
In the long run , AS is independent of the price level and is determined by the level of all factors of production and the quality of technology . The LRAS is a measure of a country’s potential output and the concept is linked to the idea of PPF ; it shows the productive potential of the economy . It shows the full capacity output i.e. where all resources are being fully utilised , and this can be linked to output gaps between the GDP trend line and the actual GDP .
Labour Productivity
Labour Productivity is a measure of efficiency indicated by output per person employed or value of output per hour worked .
Infrastructure
Infrastructure includes physical capital such as transport networks , energy , power and water supplies , and telecommunications networks .
How do LRAS and SRAS differ ?
In the short run it is possible for an economy to exceed the maximum potential aggregate supply 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 .
How do technological advances influence LRAS?
Technological advances : Improvements in technology shift the LRAS curve to the right , meaning more can be produced . This is because it will speed up production , so more goods can be produced with the same amount of resources . Increased investment in technology , whether new technology or current technology , will increase the LRAS as it means that more goods can be produced because there are more machines etc.
Factors influencing LRAS
- Technological advances
- Changes in relative productivity
- Changes in education and skills
- Demographic changes and migration
- Changes in government regulations
- Infrastructure and Efficiency
How do changes in relative productivity 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. Additionally, if the UK is more productive than other countries it will encourage production of that good in the UK, so investment will be increased, and this will increase LRAS.
How do changes in education and skills influence LRAS?
Changes in education and skills : A more skilled workforce will be more employable and work quicker and more efficiently within their jobs , so the output per worker will increase , which will shift the LRAS to the right . 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 .
How do demographic changes and migration influence LRAS?
Demographic changes and migration : If immigration is higher than emigration , the population will grow and so therefore there will be more workers which will increase the LRAS . The value and importance of this immigration will depend on the age of the immigrants and their skills . 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 .
How does infrastructure influence LRAS?
Infrastructure and Efficiency : Improved infrastructure ( e.g. , transport systems) reduce firm costs and supports a rightward shift in the LRAS curve . Conversely , inefficiencies like road congestion raise costs and shift the curve left .
How do changes in government regulation influence LRAS?
The government can increase the size of the workforce by:
* Encouraging people to go back to work and decreasing the level of inactivity.
* Offering free childcare at pre-school to entice stay-at-home mums back to work.
* Reducing benefits to encourage those living off benefits to find a job.
* Changing the working age to expand the workforce.
* Increasing research and development by offering tax breaks to businesses who invest in research.
* Making it easier to set up businesses and increasing incentives to be entrepreneurial.
* Lowering corporation tax to increase companies, jobs, and output.
* Reducing high regulation on businesses to limit costs and time taken to undertake tasks.
How does competition policy influence LRAS?
Competition policy promotes competition between businesses and markets, forcing them to improve product quality or lower prices. To achieve this while making a profit, businesses must improve efficiency, producing more goods and services, which increases LRAS. However, less competition can be beneficial if it encourages innovation. Copyright laws, for instance, prevent copying of new ideas, encouraging businesses to research and benefit from higher profits.
Who first came up with classical economic theory ?
An influential school of macroeconomists , known as the Monetarist School , argued that the economy would always converge on an equilibrium level of output that they referred to as the natural rate of output . This was based on arguments that originated with the classical economists .
Monetarist School
Monetarist School - a group of economists who believed that the macroeconomy always adjusts rapidly to the full employment level of output , and that monetary policy should be the prime instrument for stabilising the economy
Natural rate of output
Natural rate of output - monetarists believe the macroeconomy will always tend towards the long - run equilibrium level of output
Natural rate of unemployment
Natural rate of unemployment - the unemployment rate that will exist when the economy is in long - run equilibrium
Classical economic theory
The fundamental principle of the classical theory is that the economy is self - regulating . Classical economists maintain that the economy is always capable of achieving the natural level of real GDP or output , which is the level of real GDP that is obtained when the economy’s resources are fully employed . While circumstances arise from time to time that cause the economy to fall below or to exceed the natural level of real GDP , self - adjustment mechanisms exist within the market system that work to bring the economy back to the natural level of real GDP .
Why is the classical LRAS curve vertical ?
The vertical AS curve is based on the classical view that 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 . Associated with this long - run equilibrium was a natural rate of unemployment . If true , the long - run relationship between aggregate supply and the price level would be vertical . A change in the overall price level doesn’t affect aggregate output because the economy quickly adjusts back to full employment , operating at its potential full capacity level .
Keynesian aggregate supply curve
The Keynesian aggregate supply curve is non - linear where the elasticity of aggregate supply is dependent in part on the level of spare productive capacity at different stages of a nation’s economic cycle . There is only one curve which includes both short run and long run . The Keynesian view is that the economy may settle at an equilibrium that is below full employment , and that there is a range over which the aggregate supply curve slopes upwards .
Who first came up with Keynesian economic theory ?
John Maynard Keynes - The classical view of the LRAS curve was agreed until the 1930s when Keynes expressed the view that if the economy can be in disequilibrium for 20-30 years , it can’t be correct to imply the AS curve is vertical . Keynes came up with his own LRAS curve .
What does the horizontal part of the Keynesian AS curve show?
At low levels of output , the curve is horizontal . This means the economy is operating far below full employment ( e.g. , during a recession ) .
In this range :
- There’s a lot of unused labor and resources .
- Increases in demand lead to higher output without raising prices .
When spare capacity is high , aggregate supply will be elastic : this means that a rise in aggregate demand can be met easily by increased output and there is little threat of rising prices ( inflation ) .
What does the upward sloping part of the Keynesian AS curve show?
As the economy begins to use more resources , bottlenecks and inefficiencies emerge . For example , firms might need to offer higher wages to attract scarce workers . This causes both output and prices to rise . The elasticity of the curve falls as a country moves through an economic cycle :
a ) The amount of spare capacity declines
b ) There is the possibility of diminishing returns in production .
c ) Bottlenecks appear in the supply of key inputs including skilled labour .
What does the vertical part of the Keynesian AS curve show?
Once the economy reaches full employment , all resources are fully utilized . The LRAS becomes vertical because further increases in demand cannot increase output , only prices . The LRAS curve is vertical as with the classical view ; this is the maximum potential output with current resources and technology , so it is the PPF . The curve is not always vertical because if it were , it would imply that wages and prices decrease when unemployment is present . Lower wages would reduce costs for businesses , encouraging them to hire more workers . This increase in employment would eventually bring the economy back to full employment .
Why do wages not fall below a certain level according to Keynes ?
Keynes thought wages tend to be ‘ sticky downwards ‘ . They will not fall below a certain level because :
- unions are able to prevent wages falling too low
- businesses are unwilling to risk demotivation of their staff by offering low wages
- workers are unwilling to work unless a certain wage is offered
- there may be full employment in one area and unemployment in another area due to lack of labour mobility
- the minimum wage means wages cannot fall below a certain level
How is unemployment represented on Keynes ‘ AS curve ?
When there is high unemployment ( the horizontal line on the graph ) and a firm wants to recruit , they do not have to offer high wages to attract staff as the LRAS is perfectly elastic at this point . At the point between the perfectly elastic and relatively inelastic portions, as employment rises , there are less people looking for jobs and labour is becoming scarce enough that firms have to offer higher wages to attract the best workers .
Bottlenecks
a point of congestion in a production system that slows or stops progress. Short-term bottlenecks are temporary and often caused by a labor shortage. Long-term bottlenecks are more incorporated into the system itself and characterized by inefficient machinery or processes.
