4.2.2.6 DETERMINANTS OF LONG-RUN AGGREGATE DEMAND

Define what short run aggregate supply shows?

The total amount of goods and services that firms are willing and able to produce in an economy at different overall price levels over a period of time, when unit prices remain fixed or sticky

What is long run aggregate supply?

represents the maximum possible output when all factors of production are fully and efficiently employed

So where is LRAS on a PPF curve?

On the PPF curve line

Does a fall in the general price level, lead to an extension or contraction of the SRAS?

Contraction

What factors can cause a shift in SRAS?

• input prices

• productivity

• wages

• taxes

• import costs

• supply shocks

• subsidies

Complete the table

Define economic shock

An unexpected event hitting the economy. Economic shocks can be demand side or supply side shocks (and sometimes both) and unfavorable or favorable

Give some external shocks that affect aggregate supply?

• commodity prices

• volatile exchange rates

• level of net migration

• import tariffs

How does appreciation of a currency impact SRAS?

• price of imports (a strong pound will make it cheaper for the UK to import energy)

• the cost of protection falls

• SRAS shifts outwards

How does El Niño cause economic shocks?

Disrupts agriculture, energy grids, and global supply chains through extreme weather anomalies

• crop failure

• waterway restrictions

• pacific storms

• persistent inflation

Explain why the economy will always revert to normal capacity?

Even when producing at "normal capacity" the economy may still be capable of temporarily producing a higher level of real output

• this level of output cannot be sustained unless the LRAS curve itself shifts outwards

Define labor productivity

Measures the amount of economic goods and services produced per unit of labor input, such as per worker or per hour worked

Labor productivity calculation

Total output / Labor input

What is labor productivity affected by?

• technology

• capital investment

• human capital

What is infrastructure?

Includes physical capital such as transport networks, energy, power and water supplies and telecommunication networks

Explain how the PPF links to LRAS?

They both show the economy's product capacity

• PPF - shows productive capacity in terms of different combinations of goods

• LRAS - shows productive capacity in terms of real output/GDP

Reasons for an outwards shift in PPF

• increase in natural resources

• technological advancements

• human capital development

• investment in capital

5 key factors influencing LRAS?

1: Higher productivity of labor and capital

2. Growing population and increases labor market participation

3. Innovation and enterprise

4. Capital investment

5. Stock of natural (environmental resources)

Importance of infrastructure for development

Off grid renewables, transport infrastructure, mobile money systems, drone technologies to improve health care, improved irrigation in farming, border infrastructure, basic sanitation and waste disposable systems

Marco - short vs long run

Explain Keynes LRAS curve

Explain the Keynes LRAS curve

He argues that the LRAS in not necessarily vertical at all levels of output because the economy can have spare capacity

On the Keynes LRAS, explain each step

1. Flat section - lots of spare capacity (elastic)

2. Upwards sloping - spare capacity falling

3. Vertical - full capacity (inelastic)

When were the NICE years?

1997 - 2007

Were the NICE years a fluke? Or careful navigation of policy?

Fluke - globalization (cheaper imports, lower costs, income/consumption increases)

Policy - BoE independence in 1997

What does hysteresis state?

States that unemployment increases, more people adjust to lower standard of living, people may not be as motivated to achieve the previously desired higher living standards

Did hysteresis occur from "the great recession"?

Yes - lasting job losses, labor force exit, skills decay (left permeant scars on the labor market after the economy recovered)