In the long run, the ability of an economy to produce goods and services to meet demand is based on the state of production technology and the availability and quality of factor inputs
Key factors that have an effect on a country’s supply-side potential:
| Growth and size of economy |
“Seemingly small differences in growth rates can have a large impact over a period of many years. For example, if an economy grew by 2 per cent every year, it would double in size within 35 years; if it grew at 2½ per cent a year, it would double in size after 28 years - seven years earlier”
Source: UK Treasury
Y*t = f (Lt, Kt, Mt)
LRAS is determined by the stock of a country’s resources and by the productivity of these factor inputs (labour, land and capital).
Changes in technology also affect potential real national output.
Causes of shifts in the long run aggregate supply curve
Any change that alters the natural rate of growth of output shifts LRAS
Improvements in productivity and efficiency or an increase in the stock of capital and labour resources cause the LRAS curve to shift out. This is shown in the diagram below
An increase in the size of the productive capital stock of a country will also shift out the LRAS e.g. arising from the effects of infrastructure investment or an injection of investment from overseas (FDI)
Policies to increase long run aggregate supply
Aggregate Supply Shocks
Aggregate supply shocks might occur when there is
A sudden rise in oil or gas prices or other essential inputs such as foodstuffs used in food-processing industries. Foodstuffs are intermediate products – i.e. items used up in manufacturing goods for consumers to buy
The invention and widespread diffusion of a new production technology
A major change in the movement of migrant workers from one economy to another
Shocks and long run aggregate supply
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