2.3.3 - Long Run AS Flashcards
Define Classical Long Run Aggregate Supply
. The maximum level of output an economy can produce using all factors of production.
. It shows the productive potential of the economy
. It shows the full capacity output of the economy, meaning that there are no underutilised resources (including workers, capital, etc.) in the economy.
THINK OF PPF
Why is the classical LRAS curve vertical?
In the long-term there is a limit to how much firms can increase their supply due to capacity constraints
e.g. there is a limit to how much labour can be hired in an economy, capital equipment is fixed in supply, labour productivity has been maximised
Therefore, LRAS is fixed at any given level of real output, no matter what the price level is
This means LRAS curve is vertical
Explain how the classical LRAS can be linked to Production Possibility Frontier (PPF)
LRAS curve is the level of output associated with the production on PPF.
Any point on the PPF boundary represents the level of real output on the LRAS curve
Explain how the classical LRAS can be linked to the trend rate of growth and the output gap
LRAS curve is the level of output shown by the trend rate of growth in an economy.
When output is below or above the long term average/trend an output gap exists.
When output is above or below the LRAS curve, economic forces act to bring GDP back towards it trend rate of growth
Explain how the classical LRAS can be linked to level of full capacity
. LRAS curve shows the full capacity output of the economy
. At full capacity there are not underutilised resources in the economy. Production is at its long-run maximum.
Name two types of LRAS curve
Classical LRAS curve
Keynesian LRAS curve
Factors causing shift in LRAS curve
(Shifts are caused by quantity / quality changes in factor of production because they change the productive potential or productive efficiency of the economy)
MUST refer to Productive potential capacity and productive efficiency
. Technological advances
. Changes in education and skills
. Changes in government regulation
. Enterprise and risk taking
. Demographic changes and migration
. Competition policy
. Infrastructure improvements (VERY IMPORTANT)
. Changes in relative productivity
Explain technological advances
. Improvements in technology allow new products to be made or existing products to be produced more efficiently.
. This results in an increase in capital productivity (output per unit of capital employed). Additionally, cost of production decreases, resulting in more supply at a specific price level. This leads to an increase in the productive potential of the economy and shifts LRAS to the right from LRAS1 to LRAS 2
Explain changes in education skills
Improvements in education and skills of workers raise their productivity ( output per worker) because their human capital improves. This increases the productive potential of the economy and increase LRAS from LRAS1 to LRAS2
Explain changes in government regulation
If governments provide less regulations for new firms, it could incentive more entrepreneurs to create companies due to a lower cost of production. This increases the productive potential of the economy and leads to LRAS shifting from LRAS1 to LRAS2.
Explain demographic changes and migration
An increase in immigration of people of working age increase the productive potential of an economy shifting the LRAS curve to right. This is as the labour force of the economy increases. This can also be represented in an outward shift of PPF
An ageing population due to natural reasons or immigration reduces LRAS shifting the curve to the left. This is as working population is decreasing resulting in a decrease in productive potential of the economy. On the PPF, this can represented by an inward shift
Explain Competition policy
. Policies that increase competition such as privatisation and deregulation and trade liberalisation will force firms to be as efficient as possible and to keep costs and prices as low as possible
. This competitive drive will increase productive efficiency and increase the quality of the factors of production and increase LRAS from LRAS1 to LRAS2.
HOWEVER, competition can reduce innovation and investment by preventing smaller firms or new firms from thriving in the market due to a smaller price control. This means that the productive capacity of the economy falls, reducing LRAS and shifting it to the left.
Explain Keynesian Aggregate Supply curve
. There is spare capacity is the first section of the Keynesian curve, which means real output can increase without putting excess pressure on existing factors production given the large amount of unemployed factors in the economy
. Therefore, real GDP or output can increase without any demand pull inflation, hence why the curve is horizontal at low levels of real GDP.
. It is only when the economy reaches full capacity, pressure is put on existing factors of production, increasing the price for them and hence the cost of production of businesses, which lead to higher prices, increasing the inflation rate.
. There comes a point when no spare capacity exists, which is when the Keynesian LRAS is vertical like the classical LRAS curve.
Explain Infrastructure improvements
For example, if the local government constructs new roads, airports and ports, the cost of production will decrease for firms as transporting goods and services around the country becomes quicker, easier and efficient
. This increase the productive efficiency of the economy, increasing LRAS from LRAS1 to LRAS2.
1.) Define Productive capacity
2.) Define Productive efficiency
1.) Productive capacity is the potential output of the economy. It is found in the production possibility frontier diagram.
2.) Productive efficiency - when a firm reaches the lowest point of its average cost curve implying an efficient use of scarce resources and a high level of factor productivity.
It is when output is at is maximum at found on the PPF curve boundary or the perfect competition diagram
