Macro 5

Question 1

What is LRAS influenced by?

Answer 1

LRAS represents the capacity of the economy. It’s influenced by changes in the costs of factors of production.

Question 2

What does the classical view believe about LRAS?

Answer 2

LRAS is perfectly inelastic (vertical) at a point of full employment of all available resources. The point corresponds to the maximum possible output of the PPF.

Question 3

What does the classical view believe an economy will always return to in the long run?

Answer 3

The full employment level of output.

Question 4

What happens to the classical model in extreme periods of economic growth?

Answer 4

There can be an inflationary gap that develops in the short run, but it will self heal in the long run, and will return to the long run output but at ahigher average price level.

Question 5

What happens to the classical model in a recession?

Answer 5

There can be a recessionary gap that develops in the short run, but it will self heal in the long run, and will return to the long run output but at a lower price level.

Question 6

How is LRAS shaped in the Keynesian model?

Answer 6

It’s L shaped.

Question 7

What does the Keynesian model believe about supply?

Answer 7

Supply is elastic at lower levels of output as there’s a lot of spare capacity in the economy.

Question 8

What does the Keynesian model believe about the economy and full employment output?

Answer 8

The economy does not self heal so it won’t return to the full employment level of output. It can be stuck at an equilibrium well below YFE, eg. the Great Depression.

Question 9

What does the Keynesian model believe struggling firms will do?

Answer 9

Increase output without raising prices.

Question 10

What does the Keynesian model think about supply at YFE?

Answer 10

It’s perfectly inelastic (vertical).

Question 11

What does the Keynesian model believe about price inflation?

Answer 11

It increases the closer it gets to the full employment level of output as firms are competing for scarce resources and all available resources are used.

Question 12

What does the Keynesian model believe about the government?

Answer 12

There’s a role for the government to increase its expenditure to shift AD.

Question 13

What does Keynes believe low output leads to in an economy?

Answer 13

High unemployment and low consumer confidence which stops further investment and further reduces consumption.

Question 14

How do technological advances affect LRAS?

Answer 14

These often improve the quality of factors of production.

Question 15

How do changes in education and skills affect LRAS?

Answer 15

Over time this increases the quality of labour in an economy.

Question 16

How do changes in government regulations affect LRAS?

Answer 16

These can improve the quantity of the factors of production. e.g. deregulation of fracking (extracting oil from shale deposits) increased oil reserves.

Question 17

How do demographic changes and migration affect LRAS?

Answer 17

A positive net birth rate or positive net migration rate will increase the quantity of labour available.

Question 18

How does competition policy affect LRAS?

Answer 18

Regulating industries so as to prevent monopoly power results in more firms supplying goods/services in an economy and this increases the potential output of an economy.