4.2.2.6 - Determinants of Long-run Aggregate Supply

Question 1

What is the LRAS influenced by?

Answer 1

The economy’s production potential (not the price level).

Question 2

What is the normal capacity level of output?

Answer 2

The level of output at which the full production potential of the economy is being used.

Question 3

What is the position of the LRAS curve determined by?

Answer 3

• State of technical progress
• Quantities of FoP in the economy
• Mobility of FoP (particularly labour)
• Productivity of FoP
• Personal enterprise
• Appropriate economic incentives

Question 4

What are the two theories for the LRAS curve?

Answer 4

• The vertical LRAS curve
• The ‘inverted L-shape’ LRAS curve

Question 5

Who theorised the inverted L-shape LRAS curve?

Answer 5

John Maynard Keynes.

Question 6

What was Keynes’ rationale for the inverted L-shape LRAS curve?

Answer 6

Wages are ‘sticky downwards’ (i.e. at the vertical and upward-turning section). Employees will not accept lower wages just because unemployment is lower. As a result, the economy can settle in equilibrium in the long run below the level of full employment.
Alongside this, at low levels of output (i.e. the horizontal section), it is possible to expand output without putting any upward pressure on the price level whatsoever.