What is the LRAS?
Long run aggregate supply (LRAS) represents the maximum possible output; it is similar to PPF.
It represents that maximum output when all factors of production are fully and efficiently employed.
But limit to how much firms can increase their supply - run into capacity constraints
Main factors causing a shift in LRAS
The main factors causing a shift in LRAS are a change in the total quantity and quality of an economy’s factors of production
How are the maximum output level and general price level linked in LRAS?
This maximum output level is independent of the price level.
An outward shift of LRAS signifies:
An increase in potential output and employment and signifies real growth
In the long run, what is the ability of an economy to produce goods and services to meet demand based on
The state of current technology and the availability and quality of factor inputs
What does productivity measure and how can it be measured?
- Productivity measures the efficiency of the production process.
o Output per worker employed.
o Output per person hour.
o Value added from each extra factor input employed.
Significance of increased productivity
Countries with strong labour productivity growth tend to benefit from high rates of growth and low inflation. But productivity affects other macroeconomic objectives
How does increased productivity affect inflation?
Lower – unit costs falling, outward shift of aggregate supply if productivity is rising faster than wages
How does increased productivity affect economic growth (real GDP)
Higher – gains in aggregate supply, expansion of AD
How does increases productivity affect unemployment?
Lower in long run as real GDP growth rises
how does increased productivity affect business investment?
Higher – business profits will have increased – giving them more resources to fund capital spending
Economic Benefits of Net Inward Migration
- Migrants provide fresh skills = higher productivity.
- Migrants increase size of active labour supply – expanding country’s LRAS
- often a driver of innovation
- Positive multiplier effects (tax+ reinvest)
- Tax revenues: Legal immigrants in work pay taxes and are likely to be net contributors to government finances.
what are the main aims of competition policy?
o promote competition between firms (which should bring prices down for consumers and encourage innovation) and improve the efficiency of markets
what do technological advances do to the country’s LRAS?
technology usually provides more capital, but it can make existing factors of production more efficient or stimulate the growth of brand-new industries.
automation will __ productivity but ___ job loss/insecurity
increase
increase
Possible advantages of automation:
- Improved product quality – fewer mistakes will be made, and precision may be improved
- Shorter working weeks for labour
- Rising productivity
- Safer working conditions
- Lower operating costs for businesses 24/7 + no off days
Possible disadvantages of automation:
- Job loss for some workers, if their work is easily replicated by machines
- Initial large capital expenditure by businesses – make it difficult for smaller firms to compete
- Possibility of reduced flexibility, if businesses are using specialist machinery
- Possible risk of hacking
define Human capital
The skills, experience, aptitudes and attitudes of human input into the production process
brain drain definition
highly skilled workers might decide to emigrate to other countries where they can receive higher pay, however may end back remittances
Why can’t we exceed maximum production potential like we do in the short run?
- allowing factors to work overtime, etc is not sustainable as workers will eventually take a break and machines will eventually stop working
What do classical economists base their theory of a vertical LRAS curve on?
Based on the classical view that markers tend to correct themselves quickly, markets will return to equilibrium at some point
When did Keynes disagree with the classical LRAS curve?
- After the Great Depression in the 1930s
- he said if market is in disequilibrium for 20-30 years, a vertical curve can’t be correct
Why did Keynes believe wages were sticky downwards?
Believed they wouldn’t fall below a given point because:
- unions able to prevent wages falling too low
- business unwilling to risk démotivation of staff
- workers only working at a min given wage
Explain the Keynesian LRAS curve in relation to employment and price levels
- when there is high unemployment (horizontal line) and firms willing to recruit - they don’t have to offer high wages (perfectly elastic LRAS)
- between A and B, as employment rises - scarcity of labour - firms offer higher wages to attract best workers = higher price level
- output becomes more price inelastic until it reaches B, where increase in prices does not affect output as PPF has been reached
