Long Run Aggregate Supply Quiz

Questions and Answers

Define long run.

A time period long enough that all factors of production can be changed.

Define Long Run Aggregate Supply.

The maximum level of output an economy can produce using all factors of production at sustainable levels.

What is the neo-classical LRAS curve?

The classical LRAS curve is fixed and vertical at the full employment level of output.

Why is the neo-classical LRAS fixed at the full employment level of output?

Because classical economists believe that there is only one long-run equilibrium (YF1) which the economy will always return to in the long run. Signup and view all the answers

Why do neo-classical economists believe the LRAS curve is vertical (perfectly inelastic)?

Because they believe that the potential output of the economy is dependent on the quantity and quality of all factors of production and is independent of the price level. Signup and view all the answers

What is the key difference between the neo-classical LRAS curve and the Keynesian LRAS curve?

Neo-classical economists believe that the economy will operate at the natural rate of unemployment, whereas Keynesians believe that even in the long run, there can be unemployment above the natural rate. Signup and view all the answers

Why is the Keynesian LRAS curve horizontal (perfectly elastic) at low levels of output/real GDP?

As this indicates a large level of spare capacity in the economy, Keynesians believe that output can increase without putting excess pressure on existing factors of production. Signup and view all the answers

What does a horizontal LRAS curve at low levels of GDP indicate about the price level?

Real GDP can increase without any demand-pull inflationary pressure. Signup and view all the answers

What do Keynesian economists believe happens at the horizontal full capacity level of output on the LRAS curve?

Pressure is placed on existing factors of production, which increases the price of inputs and thus the cost of production for firms in an economy. Signup and view all the answers

What do Keynesian and neo-classical economists agree on and why?

That there comes a point where no spare capacity exists and so real GDP cannot increase without large increases in inflationary pressure therefore the LRAS curve becomes vertical. Signup and view all the answers

What causes a shift in the LRAS curve either left or right?

A change in the quantity or quality of factors of production or productive efficiency. Signup and view all the answers

What are the 6 determinants of shifts in the LRAS curve?

Labour productivity, investment, infrastructure improvement, competition, immigration, the institutional structure of the economy. Signup and view all the answers

How can improvements in the productivity of labour lead to a shift in the LRAS curve?

Any improvements in education or adult training will improve their skills and thus the quality of human capital. Signup and view all the answers

How can increased investment lead to a shift in the LRAS curve?

By upgrading a firm's machinery, improving technology, or building a new factory will improve both the quantity and quality of the economy's capital stock. Signup and view all the answers

How can infrastructure improvements lead to a shift in the LRAS curve?

Spending on transport infrastructure/improving the quality of roads reduces the cost of production of firms as transporting goods and services around the country becomes quicker and more efficient. Signup and view all the answers

How can competition lead to a shift in the LRAS curve?

Privatization, trade liberalization, and deregulation will force firms to be as efficient as possible. Signup and view all the answers

How can immigration lead to a shift in the LRAS curve?

An increase in the number of immigrants of working age will lead to an increase in the size of the labor force. Signup and view all the answers

How can the institutional structure of the economy lead to a shift in the LRAS curve?

Banks and other financial intermediaries perform a crucial role of accepting deposits and converting them into loans for entrepreneurs and firms. Signup and view all the answers

Study Notes

Long Run Definition

Long run refers to a time period sufficient for all factors of production to be adjusted.

Long Run Aggregate Supply (LRAS)

LRAS denotes the maximum sustainable output level of an economy using all production factors.

Neo-Classical LRAS Curve

The neo-classical LRAS curve is vertical and fixed at full employment output, reflecting a single long-run equilibrium.

Full Employment Output

Classical economists assert a return to one equilibrium output level (YF1) in the long run, justifying the vertical nature of the LRAS curve.

Price Level Independence

Neo-classical thinkers claim LRAS is perfectly inelastic since potential output relies solely on production factors, independent of price levels.

Differences in Economic Theories

Neo-classical economists maintain operation at the natural unemployment rate, while Keynesians acknowledge the potential for unemployment above this rate in the long run.

Keynesian LRAS Characteristics

At low output levels, the Keynesian LRAS curve is horizontal, indicating spare capacity and the ability to increase output without straining production factors.

Demand-Pull Inflation

A horizontal LRAS at lower GDP levels suggests real GDP can rise without inciting demand-pull inflation.

Full Capacity Pressure

Keynesians note that reaching horizontal full capacity raises production costs, pressuring input costs and leading to higher inflation rates.

Agreement Between Economists

Both Keynesian and neo-classical economists agree that at full capacity, real GDP cannot grow without triggering inflation, causing LRAS to become vertical.

Shifts in LRAS Curve

LRAS shifts left or right due to changes in the quantity/quality of production factors or improvements in productive efficiency.

Determinants of LRAS Shifts

Major determinants include labor productivity, investment, infrastructure enhancements, competition levels, immigration, and institutional quality.

Productivity Improvements

Enhancements in education and training uplift labor skills, thereby increasing the quality of human capital and shifting LRAS rightward.

Role of Investment

Investments in machinery, technology, or new facilities boost capital stock and productive efficiency, resulting in a rightward shift of LRAS.

Infrastructure Impact

Improvements in transport infrastructure lower production costs by facilitating quicker and more efficient goods movement, enhancing competitive efficiency.

Effect of Competition

Measures like privatization and deregulation necessitate efficiency among firms, leading to lower costs and prices, thus increasing overall productive efficiency.

Immigration Influence

An influx of working-age immigrants expands the labor force and potentially improves quality, shifting the LRAS curve to the right.

Institutional Structure Role

Efficient banks and intermediaries bridge savers and borrowers, supporting economic growth by enabling firms to access necessary financing.

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Description

Test your understanding of long run concepts in economics with this quiz. Explore definitions and characteristics of Long Run Aggregate Supply, including the neo-classical LRAS curve. Perfect for students studying macroeconomic theory.