2.3.2 Long-run AS

    Cards (18)

    • What did the classical economists believe
      In the long-run all markets will clear meaning that there can be no gap between actual and potential output in the long-term, and instead the economy will always return to producing at its maximum potential level of output
    • What does a classical LRAS curve mean when there is a change in price level
      A change in price level does not affect overall output because the economy will always adjust to full employment
    • For example an economy can operate beyond full employment by firms utilising their factors of production more intensively (e.g. overtime). However, in the long-run this will mean higher input costs (wages) and reduce real output back to full employment
    • Another example would be that an economy that is operating below full employment will automatically adjust back to full employment. In this scenario workers will be willing to take lower wages, due to lower price levels and the existence of unemployed workers who could replace them(creates competition) . This wage flexibility is the key argument of the classical school and means the economy will return to full employment
    • What is the belief of a Keynesian economist
      Keynesian economists believe that is possible to have long-run equilibrium where markets do not clear and so there is spare capacity in the economy in the long-run
    • What do Keynesian economists believe differently compared to classical economists
      Keynesian economists disagree that wages will fall in order to clear labour markets, when output is below employment. They believe that wages are sticky downwards
    • The Keynesian LRAS curve has elastic LRAS, which means price levels won't rise as much, this is because costs will not rise substantially when there is spare capacity in the economy, workers won't bargain for wages when there are high unemployment rates, therefore costs won't increase therefore prices won't increase
    • For the Keynesian model, as spare capacity begins to be used up, a rise in real national output will cause the costs of factors of production to rise, so the price level will rise with output. Workers will begin to bargain wages higher and there will be shortages of key raw materials as demand rises. LRAS becomes inelastic here
    • The last bit of the Keynesian curve is when full employment is reached, all the factors of production are being used here therefore it is a vertical line at the end
    • What is a movement along LRAS caused by
      A change in the price level
    • On a classical school model, a movement along the curve will have no impact on real output
    • A movement on the Keynesian LRAS curve will impact on real output assuming the economy is not at yfe.
    • What do the shifts in LRAS relate to
      The factors of production, LRAS will increase if there is an increase in the quantity and quality of these factors of production.
    • What are the factors that will cause a shift in LRAS
      Changes in relative productivity
      Discovery of new raw materials
      Net investment
      Demographic changes and migration
      Changes in government policy
      Education and skills
      Technological advances
      Competition policy
    • Explain how net investment causes a shift in LRAS
      When business investment exceeds depreciation then net investment will be positive. This will lead to the productive potential, as more capital goods are being replaced as well as there being more available, this will shift LRAS outwards
    • Explain how changes in government policy will lead to a shift in LRAS
      the government may try and boost the quantity of labour in the workforce in order to boost the productive potential of the economy. For example they may increase the incentive to work by reducing overall unemployment benefits and reducing levels of income tax
    • Explain how competition policy will lead to a shift in LRAS
      Uk regulators aim to promote competition between firms. Greater competition gives firms an incentive to be more efficient in order to compete for higher profits and to ensure survival. This boosts the productive potential of the economy and LRAS
    • Explain how technological advances will lead to a shift in LRAS
      If there are technological advances such as better production machinery then this will boost the quality of capital. This will boost the productive potential of the economy and LRAS as more can be produced with these more productive and efficient capital goods