2.3.3 Long run aggregate supply (LRAS)

Question 1

Explain what long run AS is

Answer 1

In the long run, the ability of an economy to produce goods and services to meet demand is based on the state of production technology and the availability and quality of factor inputs. This is independent of the price level in the economy. An outwards shift of the LRAS curve represents an increase in potential GDP / potential output / potential employment.

Question 2

What are changes in a nation’s potential GDP bought about by?

Answer 2

Question 3

What does the Classical view of LRAS look like?

Answer 3

Question 4

What is productivity?

Answer 4

• Productivity measures the efficiency of the production process
• In the long run, productivity is a major determinant of economic growth and of inflation.

Question 5

What can productivity can be measured by?

Answer 5

Productivity can be measured by:
* Output per worker employed
* Output per person hour
* Value added from each extra factor input employed

Question 6

How is national output made?

Answer 6

Question 7

Explain the significance of increased productivity on each macroeconomic objective

Answer 7

Question 8

We would expect positive net inward migration to shift the LRAS curve outwards. List the reasons why.

Answer 8

1. Migrants provide fresh skills and higher labour productivity
2. An increase in the size of the active labour supply – expanding a country’s potential output
3. A driver of innovation and entrepreneurship
4. Positive multiplier effects if migrants find paid work
5. Reducing skilled-labour shortages in growing industries
6. Remittances sent home by migrants add to the GNI of home nations – creating potential for rising exports
7. Tax revenues: Legal immigrants in work pay taxes and are likely to be net contributors to government finances.

Question 9

What are the risks of net inward migration?

Answer 9

1. Welfare costs: Increasing cost of providing public services
2. Possible displacement of domestic workers
3. Social tensions from the problems of integrating thousands of extra workers into local areas and regions.
4. Rising demand for housing which forces up property prices and housing rents for many groups in the
   population
5. Poverty risk: Migration may worsen the level of relative poverty in a society. And many migrant workers have
   complained of exploitation by businesses that have monopsony power in a local labour market.

Question 10

As evaluation, what do the effects of labour migration depend on?

Answer 10

• The types of people and their skills who choose to migrate from one country to another i.e. the human capital
  of migrants may be more significant in the long run
• The ease with which migrant workers settle into a new country and whether they find regular jobs
• Whether a rise in labour migration stimulates extra capital spending by firms and by government e.g. in new
  schools, hospitals, and investment by retail businesses
• The dynamic effects of migration e.g. Gains in innovation and research from notable migrant entrepreneurs,
  scientists and other groups
• Whether migrants decide to stay in the longer term or whether they regard it as temporary (e.g. to gain qualifications, learn a new language)

Question 11

How can waves of inward migration have long term effects on a country’s overall macroeconomic performance?

Answer 11

Question 12

What are other factors affecting LRAS?

Answer 12

Anything that causes a change to an economy’s factors of production (land, labour, capital, enterprise), in terms of either their quantity or their quality, will affect an economy’s LRAS. Other factors include competition policy, technological advances, education and skills,
government regulations, and other demographic changes.

Question 13

What is the main aim of competition policy?

Answer 13

The main aims of competition policy are to promote competition between firms (which should bring prices down for consumers and encourage innovation) and improve the efficiency of markets. UK competition policy is very much focused on protecting consumers.

Question 14

What are the 4 main pillars of competition policy?

Answer 14

1. Antitrust and cartels
2. Market liberalisation
3. State aid control
4. Merger control

Question 15

Explain how antitrust and cartels are a pillar of competition policy.

Answer 15

this involves eliminating (illegal) agreements that restrict competition, and any abuse of
market power (i.e. anti-competitive behaviour such as price-fixing by firms that have significant market share)

Question 16

Explain how market liberalisation is a pillar of competition policy.

Answer 16

this involves introducing competition or contestability (i.e. increasing the probability of
competition) in sectors that have previously been dominated by large monopolistic firms (e.g. energy
suppliers, postal services, mobile telecommunications, air transport and retail banking). This can be achieved
by using deregulation, privatisation, and breaking up markets into different sectors e.g. separating energy
generation from energy supply.

Question 17

Explain how state aid control is a pillar of competition policy.

Answer 17

this involves analysing the role of the state in supporting industries (perhaps via subsidies)
to ensure that this does not overly distort competition

Question 18

Explain how merger control is a pillar of competition policy.

Answer 18

this involves investigating mergers between firms, or takeovers, to ensure that they do not
end up having monopoly power and reducing competition

Question 19

What is deregulation?

Answer 19

Deregulation is removing legislation and laws imposed by the government on a particular market.

Question 20

What is an example of deregulation?

Answer 20

Airline deregulation in the US. In 1978, the US government deregulated the airline industry allowing for an increase in competition. This resulted in a 33% decrease in the prices of tickets and helped lower costs airlines and smaller airports.

Question 21

How can technological advances impact on an economy?

Answer 21

Changes in technology can have significant impacts on an economy’s LRAS. Not only does technology usually provide more capital, but it can also make existing factors of production more efficient or stimulate the growth of brand-new industries.

Question 22

What are some recent advances in technology that might prove to impact on LRAS (according to MIT)?

Answer 22

• 3D metal printing
• Cloud based Artificial Intelligence
• Blockchain
• Quantum computing
• Custom vaccines

Question 23

Why are there concerns over increasing automation?

Answer 23

Increasing use of robots and machines
to replace humans will certainly increase productivity, but there have been worries about job-loss, especially amongst low-skilled workers, because of the speed of change. It looks likely that workers will need to have good IT skills and strong transferable skills to be able to move between sectors and jobs if needed.

Question 24

What are possible advantages of automation?

Answer 24

1. Improved product quality – it is likely that fewer mistakes will be made, and precision may be improved
2. Shorter working weeks for labour
3. Rising productivity
4. Safer working conditions
5. Lower operating costs for businesses (i.e. no ‘sick days, able to operate 24 hours a day 7 days a week etc.)

Question 25

What are possible disadvantages of automation?

Answer 25

1. Job loss for some workers, if their work is easily replicated by machines 2. Initial large capital expenditure by businesses – this may make it difficult for smaller firms to compete 3. Possibility of reduced flexibility, if businesses are using specialist machinery 4. Possible risk of hacking

Question 26

How can a highly trained labour force increase an economy's LRAS?

Answer 26

A highly trained / highly skilled labour force should increase an economy’s LRAS, because each worker is capable of producing more output; higher human capital raises productive capacity. In some developing countries, however, highly skilled workers might decide to emigrate to other countries where they can receive higher pay – this is known as a ‘brain drain’. However, these workers may send remittances back to their home country to support families there

Question 27

What are the key changes to the UK's demography (other than migration)?

Answer 27

Question 28

Explain the reasoning behind the Keynesian AS curve

Answer 28

When spare capacity is high, AS will be elastic (that is, output can be increased without a significant change in the price level): The elasticity of the AS curve falls as output increases i.e. it becomes increasingly more difficult to raise output * The amount of spare capacity declines * Possibility of diminishing returns in production * Bottlenecks in supply of inputs and components * Resource shortages as the economy approaches full employment e.g. Skilled labour becomes scarce When AS is perfectly inelastic, an economy is at full capacity (equivalent to being on the PPF boundary); further increases in AD are purely inflationary in the short run with little extra real output

Question 29

When the Keynesian AS curve is elastic, show what happens.

Answer 29

Question 30

When the Keynesian AS Curve is inelastic, show what happens

Answer 30

Question 31

Explain what full employment is

Answer 31

* When the AS curve become vertical, the economy has reached full-employment of factor resources. * Full employment is defined as a state of the labour market in which everyone who is willing and able to work at the current wage rate is in employment, excluding those who are frictionally unemployed.

Question 32

What does full employment look like?

Answer 32

Question 33

What does an increase in productive potential look like using the Keynesian LRAS diagram?

Answer 33

Question 34

Draw a table outlining the differences between the Keynesian and Neoclassical viewpoints

Answer 34