2.6 Determinants of LRAS

Question 1

What is the assumed shape of the LRAS curve?

Answer 1

• That It is vertical
• This view suggests that output is fixed at each level.
• All factors of production in the economy are fully employed in the long run.
• This means that changing AD, such as from AD1 to AD2, only makes a change in the price level and it will not change national output (real GDP).
• The position of the vertical LRAS curve represents the normal capacity level of
  output of the economy.

Question 2

What factors influence changes in the LRAS curve?

Answer 2

• The LRAS curve is influenced by changes which affect the quantity or quality of the factors of production.
• This is equivalent to shifting the PPF curve i.e. when the
  economy is operating at full capacity.
• Technological advances
• Changes in relative productivity
• Changes in education and skills
• Changes in government regulations
• Demographic changes and migration
• Competition policy

Question 3

Factors influencing LRAS-technological advances

Answer 3

• If more money is spent on improving technology, the economy can produce goods in larger volumes or improve the quality of goods and services produced.

Question 4

Factors influencing LRAS- Changes in relative productivity

Answer 4

• A more productive labour and capital input will produce a larger quantity of output with the same quantity of input.

Question 5

Factors influencing LRAS- changes in education and skills

Answer 5

• This improves the quality of human capital, so it is more productive and more able to produce a wider variety of goods and services.

Question 6

Factors influencing LRAS-Changes in government regulation

Answer 6

• Government regulation could limit how productive and efficient a firm can be if it is excessive.
• This is sometimes referred to as ‘red-tape’.

Question 7

Factors influencing LRAS-Demographic changes and migration

Answer 7

• If there is net inward migration and the majority of the population is of working age, the size of the labour force is going to be significant, which means the economy can increase its output

Question 8

Factors influencing LRAS- Competition policy

Answer 8

• A more competitive market encourages firms to be more efficient and more
  productive, so they are not competed out of business.
• Governments can use effective competition policy to stimulate this in the economy.

Question 9

What is the Keynesian view of the AS curve?

Answer 9

• The Keynesian view suggests that the price level in the economy is fixed until
  resources are fully employed.
• Over the spare capacity section, output can be increased without affecting the price level. In other words, output changes are not inflationary.
• Once resources are fully employed, an increase in output will be inflationary