2.3.3 Long-run AS (LRAS)

LRAS is about the productive capacity of the economy—the maximum output possible when all factors of production are fully utilized.

A. Different Shapes of the LRAS Curve

This is a favorite for 25-mark evaluation questions. You must know the "why" behind each shape:

  • Classical (Neo-Classical): * Shape: A vertical line.

    • Theory: In the long run, the economy will always operate at full capacity ($Y_{fe}$). Any increase in AD will only cause inflation, not more output, because markets "clear" and wages/prices are flexible.

  • Keynesian: * Shape: A curve with a horizontal section, a "bottleneck" section, and a vertical section.

    • Theory: An economy can be in equilibrium below full employment.

    • The Horizontal Part: High unemployment; AD can rise without inflation.

    • The Vertical Part: Full capacity reached; any further AD increase is purely inflationary.

B. Factors Influencing LRAS (The "Capacity Shifters")

Anything that increases the Quantity or Quality of the factors of production (Land, Labor, Capital, Enterprise) will shift the LRAS to the right.

  1. Technological Advances: New tech allows more to be produced with the same resources (e.g., AI or automation).

  2. Changes in Relative Productivity: Increasing "Output per worker" through better management or investment in capital machinery.

  3. Education and Skills: Improving "Human Capital." A more skilled workforce is more productive and innovative.

  4. Government Regulations:

    • Deregulation: Cutting "red tape" lowers business costs and encourages expansion.

    • Privatisation: Often leads to increased efficiency and investment.

  5. Demographic Changes and Migration: An increase in the working-age population (e.g., through net migration) increases the labor supply and potential output.

  6. Competition Policy: Laws that prevent monopolies or encourage new firms to enter markets force efficiency, shifting LRAS right.

Evaluation Power-Up: The "Trade-Off" Analysis

When discussing LRAS shifts, evaluate the Conflict of Objectives. For example: "While supply-side policies shift LRAS right and allow for non-inflationary growth, they often involve huge opportunity costs (spending on education) or may increase inequality (if trade union power is reduced to encourage labor flexibility)."