2.3.3 Long-Run Aggregate Supply

Edexcel A-Level Economics (9EC0) | Theme 2.3.3

Specification Coverage: Edexcel unit 2.3.3 - Long-Run Aggregate Supply. Students should be able to understand and explain what LRAS is, the Classical and Keynesian views of the LRAS curve, the factors that shift LRAS, and how changes in LRAS represent long-run economic growth and changes in productive potential.

What Is LRAS?

Definition: Long-run aggregate supply is the total potential output of an economy when all factors of production are fully and efficiently employed.

It represents the economy's productive capacity.

Key Idea: Shifts in LRAS represent long-run economic growth or decline, which is equivalent to an outward or inward shift of the production possibility frontier.

Two Views of the LRAS Curve

Economists disagree about the shape of the LRAS curve, leading to two main models.

The Classical View

Belief: In the long run, the economy will always adjust to full employment through flexible prices and wages.

The Curve: LRAS is perfectly inelastic, so it is vertical at the level of output corresponding to full employment, Yfe.

Diagram showing the LRAS curve.
Figure 1: The Classical LRAS curve is vertical, reflecting the belief that the economy will always adjust to full employment in the long run.

Analysis: In this view, any change in aggregate demand changes only the price level in the long run, not the level of real output.

The Keynesian View

Belief: The economy can be stuck in equilibrium below full employment because of weak confidence, animal spirits, and sticky wages and prices. Government intervention may therefore be needed.

The Curve: LRAS is non-linear and often shown as L-shaped.

  • It is perfectly elastic at low output where there is large spare capacity.
  • It becomes upward sloping as the economy approaches capacity and inflationary pressures build.
  • It becomes vertical at full capacity output, Yfe.
Diagram showing the LRAS curve.
Figure 2: The Keynesian LRAS curve is L-shaped, reflecting the idea that the economy can be below full employment for a long time, but as it approaches full capacity, the curve becomes vertical.

Analysis: In a recession, increases in aggregate demand can raise real output without necessarily causing inflation.

Factors Influencing LRAS

Any change in the quantity or quality of the factors of production, including land, labour, capital, and enterprise, will shift LRAS and change the economy's productive potential.

Diagram showing the LRAS curve.
Figure 3: Factors that increase the quantity or quality of factors of production, such as technological advances or increased investment, will shift the LRAS curve to the right, indicating an increase in the economy's productive potential.
Factor Effect on LRAS Example
Technological Advances Improve the quality of capital and make production more efficient. AI, automation, and new manufacturing techniques.
Changes in Education and Skills Improve the quality of labour and create a more productive workforce. Greater spending on training and higher education.
Changes in Productivity Increase output per worker or per hour, allowing more to be produced from the same inputs. Better management and improved production processes.
Demographic Changes and Migration Increase the quantity of labour and expand the working-age population. Positive net migration or a rising birth rate.
Increase in Capital Stock Increase the quantity of capital, such as machinery and infrastructure. High levels of investment by firms and government.
Competition Policy and Deregulation Improve efficiency and encourage enterprise and innovation. Breaking up monopolies and reducing barriers to entry.
Institutional Improvements Improve the quality of institutions and encourage investment. Stronger property rights and lower corruption.

Exam Preparation

  • Draw and explain both the Classical vertical LRAS curve and the Keynesian L-shaped LRAS curve.
  • Understand the policy difference: Classical economists argue that the economy self-corrects, while Keynesians argue that active government intervention is often necessary.
  • Identify factors that cause outward shifts in LRAS and therefore contribute to long-run economic growth.
  • Analyse economic growth as an outward shift of LRAS and of the production possibility frontier.
  • Evaluate which LRAS view is more appropriate in different contexts, such as a deep recession compared with a period of steady growth.