3.2.4 Shifts of the Long-Run Aggregate Supply (LRAS)

• Classical economists believe that the long-run aggregate supply (LRAS) can increase in the long-run
• Keynesian economists believe that aggregate supply can increase in the long-term
    
• The following factors will shift the entire Classical LRAS curve, or the Keynesian AS curve outwards, thus increasing the potential output of the economy. This corresponds to an outward or inward shift on the production possibilities curve for an economy

1. Changes in the quality or quantity of the factors of production: Any factor that increases the quantity or quality of a factor of production will increase the productive potential of an economy e.g. improving the skills of workers or changing the migration policies so that there is an increase the quantity of labour
2. Technological advances: these often improve the quality of the factors of production e.g. development of metal alloys
3. Efficiency improvements: process innovation often results in productivity improvement e.g. moving from labour intensive car production to automated car production
4. Changes in institutions: increasing financial institutions can result in more access to finance and help to increase the potential supply. Creating and implementing new legislation (laws) can make it easier for new firms to enter markets thus increasing supply e.g. implementation of competition policy
   
   

Exam Tip

1. Changes to LRAS in the Classical Model

• Changes to any of the determinants of LRAS will change the long-run productive potential of the economy

The Classical view of an increase in the long-run aggregate supply (LRAS) of an economy leading to lower average price levels

 

Diagram Analysis

• The initial potential output of this economy is seen at Y_FE
  • The economy is in equilibrium at AP₁Y_FE
    
    
• A change to the education level in the economy can increase the quality of labour and shift the LRAS to the right from LRAS₁→LRAS₂
  • There is now an increased level of potential output in the economy at Y_FE1
    
    
• The extra supply in the economy allows prices to fall and output to increase resulting in a new equilibrium at AP₂Y_FE1
   

2. Changes to AS in the Keynesian Model

• As with the Classical model, changes to any of the determinants of AS will change the long term productive potential of the economy

The Keynesian view of an increase in the long-term aggregate supply (LRAS) of an economy

 

Diagram Analysis

• The initial potential output of this economy is seen at Y_FE
  
• A change to the immigration policy can increase the quantity of labour and shift the AS to the right from AS₁→AS₂
  • There is now an increased level of possible output in the economy Y_FE1