Long run aggregate supply Flashcards
What does the long run aggregate supply represent?
The long-run aggregate supply (LRAS) represents the potential capacity of an economy’s factors of production
what can impact LRAS
Any factor that changes the quantity or quality of a factor of production
This corresponds to an outward or inward shift of the potential output of an economy on the production possibilities diagram
draw the shift in long run aggregate supply digram
diagram analysis
Using all available factors of production, the long-term output of this economy (LRAS) occurs at YFE
At YFE, all of the resources available in the economy are fully employed (utilised)
At YFE, the position of the vertical long-run AS curve represents the normal capacity level of output in the economy
The economy is initially in equilibrium at the intersection of AD and LRAS1 (AP1, YFE)
An outward shift of a country’s LRAS curve means that its productive capacity has increased
This fundamental expansion of the economy can be seen in the shift from LRAS1 → LRAS2
Underlying economic growth is represented by a rightward shift in the long-run AS curve
The following factors will shift the entire LRAS curve outward and increase the potential output of the economy
An improvement in the quality of the factors of production
E.g. An increase in productivity (output per unit of input)
An increase in the quantity of the factors of production
what are the factors that can change the quality or quantity
Technological advances
Changes in relative productivity: process innovation often results in productivity improvements, e.g. moving from labour-intensive car production to automated car production
Changes in education and skills: over time, this increases the quality of labour in an economy
Changes in government regulations: these can improve the quantity of the factors of production.
Demographic changes and migration: a positive net birth rate or positive net migration rate will increase the quantity of labour available
The institutional structure of the economy:
Improving the Quality and Quantity of Factors of Production - Land
increase in quality - The quality of land can increase productivity through
Irrigation schemes
Use of fertilisers
Genetic modification of crops
increase in quantity - Land can increase in quantity due to
Discovery of new resources, eg. oil reserves
Land reclamation, eg. The Netherlands reclaiming land from the North Sea
Improving the Quality and Quantity of Factors of Production- labour
increase in quality - A well-educated workforce increases overall productivity and can be achieved through:
Apprenticeship programmes
Job-related training
Increased quantity - The quantity of labour can increase due to
Increased immigration
Increase in birth rates
Fringe benefits, eg. free child care, encourages people at home to work
Improving the Quality and Quantity of Factors of Production - capital
increase in quality - Technological advances, eg. a new machine can increase output per unit and reduce cost
Research and development (R&D) can lead to more innovative processes and efficiency
increase in quantity - Increased investment in capital goods can lead to overall increase in productive capacity
Investment into infrastructure: roads, airports, technology
what does institutional structures refer to ?
Institutional structures refer to the established frameworks, organisations, regulations, norms, and practices within a society that govern the behaviour of economic agents
These structures encompass formal institutions, such as government bodies, legal systems, and regulatory agencies (e.g Competition & Markets Authority), as well as informal institutions (e.g. Confederation of British Industry)
They provide the framework within which economic activities take place, allocate resources, and govern the distribution of wealth and opportunities within a society
They define the rules of the game, establish property rights, enforce contracts, and provide the necessary infrastructure for economic growth
how do insitutional structures have significance influence on long run aggregate supply
by shaping the economy’s productive capacity, technological progress, and efficiency
Policies that promote labour market flexibility, financial stability, property rights protection, education, infrastructure development, and innovation are essential for expanding LRAS
By addressing institutional weaknesses and implementing reforms that support a conducive environment for investment, entrepreneurship, and productivity enhancement, policymakers can contribute to sustainable LRAS growth
Keynesian aggregate supply curve how is the supply curve shaped ?
Keynes believed that the long-run aggregate supply curve (LRAS) was more L shaped
Supply is elastic at lower levels of output as there is a lot of spare production capacity in the economy
Struggling firms will increase output without raising prices
Supply is perfectly inelastic (vertical) at a point of full employment (YFE) of all available resources
The closer the economy gets to this point the more price inflation will occur as firms compete for scarce resources
what odes the Keynesian view believe ?
The Keynesian view believes that an economy will not always self-correct and return to the full employment level of output (YFE)
It can get stuck at an equilibrium well below the full employment level of output e.g. Great Depression
The Keynesian view believes that there is role for the government to increase its expenditure so as to shift aggregate demand
show a diagram showing the Keynesian View of long-run aggregate supply (LRAS) with a vertical aggregate supply curve at the full employment level of output (YFE) becoming more elastic at lower levels of output
Diagram analysis
Using all available factors of production, the long-term output of this economy (LRAS) occurs at YFE
The economy is initially in equilibrium at the intersection of AD1 and LRAS (P1, YFE)
A slowdown reduces output from AD1→AD2 and creates a recessionary gap Y1-YFE
The economy may reach a point where average prices stop falling (P2), but output continues to fall
This economy may not self-correct to YFE for years
The low output leads to high unemployment and low confidence in the economy
This stops further investment and further reduces consumption
Keynes argued that this was where governments needed to intervene with significant expenditures,
what is SRAS influenced by ?
Short run aggregate supply (SRAS) is influenced by changes in the costs of production or productivity
Short run refers to the time period where at least one factor of production is fixed
what is LRAS influenced by ?
ong run aggregate supply (LRAS) is influenced by a change in the productive capacity of the economy
Productive capacity is changed by changes to the quantity or quality of the factors of production
When production capacity changes, it is equivalent to a shift inwards/outwards of the production possibilities frontier (PPF)
