Determinants of long-run aggregate supply Flashcards
What is Long-Run Aggregate Supply (LRAS)?
Long-Run Aggregate Supply (LRAS) represents the total output an economy can produce when operating at full capacity, with all resources fully employed. In the long run, LRAS is determined by the economy’s productive capacity, which depends on fundamental factors like technology, productivity, and institutional structures.
Key point: The LRAS curve is vertical because in the long run, output is independent of price level and determined only by the economy’s factors of production.
What are the fundamental determinants of Long-Run Aggregate Supply (LRAS)?
Labour Productivity: Increases in productivity, often through better training or technology, allow workers to produce more per hour, shifting the LRAS curve to the right.
Quantity of Labour: Growth in the labour force, due to factors like population growth, immigration, or higher workforce participation, expands the economy’s capacity, increasing LRAS.
Investment: Investment in physical capital (such as machinery, technology, and infrastructure) enhances firms’ productive capacity, enabling more output and shifting LRAS rightward.
Competition: Greater competition encourages firms to innovate, improve efficiency, and lower costs, which collectively boost productivity and shift LRAS to the right.
Infrastructure: Effective infrastructure, such as roads, railways, and communication networks, enhances efficiency by reducing costs and time needed for production, supporting higher output and shifting LRAS rightward.
New Resource Discoveries: Discovering new natural resources (e.g., oil, minerals) expands the supply of key inputs, allowing the economy to produce more goods and services. This increases LRAS by boosting potential output.
How does the position of the LRAS curve represent the economy’s capacity?
The position of the vertical LRAS curve represents the economy’s normal capacity level of output, also known as potential or full-employment output. This is the maximum output the economy can sustain without causing inflation.
Example: If the LRAS curve shifts right, it indicates that the economy’s productive capacity has increased, allowing for higher output without upward pressure on prices.
Why is the institutional structure of the economy important for LRAS?
Institutional structures, like the banking system, are critical as they provide necessary funds for investment. Access to capital allows businesses to finance new technologies, expand operations, and increase productivity, all of which support higher LRAS.
Example for exams: A well-developed financial system promotes economic growth by providing businesses with affordable loans, enhancing productive capacity and LRAS.
How does the banking system/ financial availability influence LRAS?
The banking system enables investment by providing funds to businesses. When banks efficiently allocate resources, firms can invest in capital goods, research, and development, which ultimately raises the economy’s productive capacity and shifts LRAS to the right.
Key exam point: Explain how an underdeveloped banking system may restrict business expansion and innovation, limiting long-term economic growth and the LRAS.
What is the Keynesian Aggregate Supply (AS) Curve?
The Keynesian AS curve differs from the classical view by being horizontal at low output levels, reflecting unused capacity and high unemployment. As output increases, it slopes upward and eventually becomes vertical at full capacity, where additional demand leads only to inflation, not more output.
In exams: Use the Keynesian AS to explain how, in a recession, increasing AD may boost output without causing inflation until full capacity is reached.
What does the shape of the Keynesian AS curve imply about economic policy?
The Keynesian AS curve suggests that during periods of spare capacity, government policies to increase AD can raise both output and employment without inflation. However, once the economy reaches full capacity, further increases in AD will only raise prices.
Application: In a recession, a Keynesian approach would advocate for fiscal stimulus to boost output, while avoiding such policies when the economy is at full capacity.
How do improvements in technology and productivity affect the LRAS curve?
Advances in technology and increases in productivity make production more efficient, allowing the economy to produce more with the same resources. These improvements shift the LRAS curve to the right, indicating higher potential output.
Example for answers: Technological innovation in manufacturing can reduce costs and increase output, enabling sustained long-term growth.
How does an increase in labour productivity affect the Long-Run Aggregate Supply (LRAS) curve?
An increase in labour productivity shifts the LRAS curve to the right. Higher productivity means each worker can produce more output, expanding the economy’s capacity.
In what ways does the quantity of labour impact the LRAS curve?
Increases in the labour force, through population growth or higher participation rates, expand productive capacity and shift the LRAS to the right, as more workers allow for higher total output.
How does investment in physical capital affect the position of the LRAS curve?
Higher investment in machinery, technology, and infrastructure increases production capacity, shifting the LRAS curve to the right by allowing more efficient and larger-scale production.
What role does competition play in shifting the LRAS curve?
Greater competition encourages innovation and efficiency among firms, which boosts productivity and reduces costs, shifting the LRAS curve to the right.
Why is infrastructure important for LRAS?
Effective infrastructure, like transportation and communication systems, improves efficiency and lowers production costs, enabling higher output and shifting the LRAS to the right.
How do new resource discoveries influence the LRAS curve?
Discovering new resources, such as oil or minerals, increases the supply of essential inputs, expanding the economy’s potential output and shifting the LRAS curve to the right.
