Post on 18-Jan-2018
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Long Run Aggregate Supply
EdExcel AS Economics 2.3.3
• Changes in a nation’s potential GDP are brought about by:• Changes in labour supply available for production (i.e.
more people joining the labour force)• Changes in the stock of capital inputs – affected by the
level of gross capital investment• Changes in the efficiency of allocation of factor inputs
e.g. shifting resources from rural to urban areas• Improvements in the quality of factor inputs /
productivity of inputs• Advances in the state of technology• Improvements in institutions such as the banking
system• An outward shift of LRAS signifies an increase in long-run
potential output and employment• A higher level of LRAS signifies real economic growth
Increasing LRAS – Lifting Productive Potential
Components of Trend Growth for the UK Economy
Data for 2015 and 2016 are forecasts published at time of July 2015 budget
Annual growth rate (per cent)
Potential
productivity (output per
hour)
Potential average hours
Potential employment rate for those
aged 16+
Potential population
growth
Overall Potential Output for the UK Economy
2015 1.4 0.0 0.0 0.6 2.12016 1.8 -0.1 -0.1 0.6 2.22017 2.0 -0.2 -0.1 0.6 2.32018 2.1 -0.2 -0.1 0.5 2.3
Trend growth is the estimated rate of growth of a nation’s productive potential. The table shows data for the UK and finds that productivity growth is the main driver of potential output over the long run. The main measure of productivity used is output per person-hour.
Key Factors affecting Long-Run Aggregate Supply
Higher Productivity of
Labour and Capital
I.e. a rise in output per person
employed or increased
efficiency of technology
Increased Labour Market
Participation i.e. A growing
labour supply and a rise in the
number of people in paid work
Gains from Innovation and
EnterpriseThese are two key
factors that determine
competitiveness especially in international
markets
Capital Investment
Including capital spending by
businesses, inward investment from
overseas (FDI) and the Public Sector
(Government)
Productivity
Productivity measures the efficiency of the production process
• In the long run, productivity is a major determinant of economic growth and of inflation.
• A fall in labour productivity leads to a rise in firms’ (unit) costs of production (assuming that the level of wages remains the same)
• Higher productivity allows businesses to pay higher wages and achieve increased profits at the same time.
Factor Inputs (land,
labour and capital)
Factor Productivity(efficiency)
Output
Impact of improved productivity on the UK Economy
All other things being equal, an improvement in labour productivity is most likely to …..
Macroeconomic Objective Comment on the Effect
Inflation Lower – unit costs will be falling
Economic growth Higher – gains in aggregate supply
Unemployment Lower in long run as growth rises
Balance of trade in goods & services Improved – more competitive exports
Spare capacity in the economy Rise from extra capacity in short run
Business investment Higher – profits will have increased
Government fiscal balance Productivity gains in government will help to reduce state spending
Explaining the non-linear AS curve
• When spare capacity is high then SRAS will be elastic• A rise in AD can be met easily by increased output• There is little threat of rising prices (inflation)
• The elasticity of SRAS curve falls as output increases• 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 more scarce• When SRAS becomes perfectly inelastic the economy is at
full capacity (equivalent to being on the PPF boundary)• Further increases in AD at this point are purely
inflationary in the short run with little extra real output
Keynesian Non-Linear Aggregate Supply Curve
General Price Level
Real GDP
AS
AD1 AD2AD3
AD4
AD5
Non-inflationary growthAn outward shift in AD from AD1 to AD2 can be met without an increase in the price level because short run aggregate supply is highly elastic
GPL1
Y1Y2
Keynesian Non-Linear Aggregate Supply Curve
General Price Level
Real GDP
AS
AD1 AD2AD3
AD4
AD5
Inflationary pressuresAn outward shift in AD from AD3 to AD4 causes a sharp rise in the general price level because AS is inelastic (i.e. output is close to full-capacity levels)
GPL4
Y3 Y4
GPL5
Keynesian Non-Linear Aggregate Supply Curve
General Price Level
Real GDP
AS
AD
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
YFE
GPL
Keynesian AS Curve and Negative Output Gap
General Price Level
Real GDP
AS
AD
YFE is full employment and at Y1, the economy is operating below full employment so it is experiencing a negative output gap
YFE
GPL
AD1
Y1
Long Run Aggregate Supply
EdExcel AS Economics 2.3.3