Download Shifting LRAS - The Good, the Bad and the Economist

Chapter 44: Shifting LRAS (2.2)
Key concepts
 Factors causing a shift in LRAS
 Effects of LRAS shifts according to the monetarist/new classical
and Keynesian model
Shifting the
aggregate supply
curve over the long
term

•
Explain, using the two models above, how factors
leading to changes in the quantity and/or quality of
factors of production, (including improvements in
efficiency, new technology, reductions in
unemployment, institutional changes), can shift the
aggregate supply curve over the long term
Factors causing a shift in LRAS
In Chapter 42 the issue was short run aggregate supply – SRAS – and three main variables
affecting SRAS were identified; price of labour, price of other factor inputs such as raw materials,
and taxation/legislation. While all of these indeed affect the long run, there are several rather
specific long run influences for LRAS:
 New oil/mineral finds, improved pesticides, better land use, superior high-yielding grain
varieties, improvements in farming methods
 Improvements in the labour force such as better education standards, immigration and
population growth, decreased income taxes incentivising households to work more
 Introduction of new technology which increases productivity levels in an economy, new
production methods (again, an increase in productivity), change in tax regulations that
encourage firms to invest, deregulation and privatisation increase capital stock in an
economy
The list can be rather lengthy. Basically anything in an economy that increases the quantity and
quality of factors of production will shift the LRAS. In Chapters 60 to 62 we will return to the
issue of how governments can intentionally change polices in order to influence long run
aggregate supply – so called supply-side policies.

Effects of LRAS shifts according to the monetarist/new classical and
Keynesian model
New classical model: Long run aggregate supply – again, representing long run potential output –
will be affected primarily by changes in the quality and/or quantity of factors of production.
However, long run aggregate supply will NOT be affected by a change in the price of factors
since the AS-AD model is built on the assumption that factor prices will adjust to any increase in
the price of final output. The long run aggregate supply curve is vertical for this very reason; it
shows potential output regardless of price level. The tenet (= basic core belief) of the new
classical school of LRAS being uncorrelated to price has serious implications for policy views put
forward by supply-side economists as shall be seen in Chapter 60.
Figure 44.1 – shifts in LRAS in the Keynesian and new classical model
Rory; these diags are so simplistic they can be minimised.
Keynesian AS
Price level
(index)
New classical LRAS
Price level
(index)
LRAS0 LRAS1
LRAS0 LRAS1
GDPreal/t
Y0
YFE
YFE
GDPreal/t
YFE
YFE
LRAS will shift due to a change in the quality and price of factors of production – BUT NOT DUE TO a
change in the price of factors. Variables which are specific to long run aggregate supply involve
potential productivity changes due to changes in the quantity and/or quality of factors, for example
changes in labour supply, technology, production methods and labour capital.
Keynesian model: The change in LR factors affecting aggregate supply cause a similar shift in the
LRAS curve. However, note that while the Keynesian version also causes the income at full
employment level to increase, there is ‘portion’ of the LRAS curve below Y0 which in fact
doesn’t change at all. This has implications for Keynesian policy responses to severe recessions
as shall be seen in Chapter 62.
Summary and revision
1. All the variables affecting SRAS will affect LRAS – except the price of factors of
production. We assume all factor prices to remain unchanged along the SRAS
curve.
2. Anything which affects the quality and quantity of factors of production will
shift LRAS.
3. Main influences on LRAS:
a. Land: increases in arable land, improvements in farming techniques, oil
and mineral finds
b. Labour: deregulation of labour markets, increase in population or labour
force, lower income taxes
c. Capital: new technology, increased investment, deregulation