What determines long-run aggregate supply

Overview

How improvements in education and training affect long-run aggregate supply, how net investment in capital raises long-run aggregate supply and how technological progress affects long-run aggregate supply.

What you need to know

Answer each one before you reveal it.

Questions from this subtopic

Each one with the model answer underneath.

1. 1

   What determines the position of the long-run aggregate supply curve?

   Model answer

   It is determined by the economy's productive potential: the quantity and quality of labour, capital, land and enterprise available, and the state of technology and the efficiency with which resources are allocated. Nothing about the general price level or the level of demand enters into it. Anything that increases what the economy is capable of producing shifts the curve to the right.

2. 2

   Analyse how an increase in the size of the labour force affects long-run aggregate supply.

   Model answer

   More workers means more labour available to combine with the existing capital stock, so the maximum sustainable output rises. On a diagram with the general price level on the vertical axis and real national output on the horizontal axis, the long-run aggregate supply curve shifts to the right, so a higher real national output is achievable at a lower general price level for any given aggregate demand. The gain depends on the skills the additional workers bring and on whether there is enough capital and infrastructure for them to work with.

3. 3

   An economy has 42 million people of working age and a participation rate of 78.6 per cent. Calculate the labour force, and calculate how many extra workers a rise in participation to 80 per cent would bring.

   Model answer

   The labour force is 42m × 0.786 = 33.012 million, so just over 33 million people are working or seeking work. At 80 per cent it would be 42m × 0.80 = 33.6 million. The increase is 33.6 − 33.012 = 0.588 million, that is 588,000 additional people in the labour force, which shifts long-run aggregate supply to the right without any change in the working-age population.

4. 4

   Net inward migration adds 200,000 people to a labour force of 33 million. Calculate the percentage increase and comment on its effect on aggregate supply and aggregate demand.

   Model answer

   The increase is 200,000 / 33,000,000 = 0.00606, or 0.61 per cent. Long-run aggregate supply shifts right because there is more labour available, easing shortages in the occupations concerned. Aggregate demand also shifts right, because the new arrivals consume goods, services and housing, so the effect on the general price level depends on which shift is larger, while real national output rises on both counts.

5. 5

   Analyse how improvements in education and training affect long-run aggregate supply.

   Model answer

   Better education and training raise human capital, so each worker produces more per hour and can move more easily between occupations as the structure of the economy changes. Higher productivity means the same workforce can produce more output, so the long-run aggregate supply curve shifts right and real national output can be higher at a lower general price level for any given aggregate demand. The effect is slow to appear, because a cohort takes years to pass through education and into work, and it depends on the training matching the skills employers actually need.

6. 6

   Analyse how net investment in capital raises long-run aggregate supply.

   Model answer

   Net investment adds to the stock of machinery, buildings, vehicles and infrastructure that workers have to work with, so output per worker rises and the maximum output the economy can produce increases. The long-run aggregate supply curve therefore shifts right, permitting higher real national output at a lower general price level. The effect operates with a delay, since capital must be installed and workers trained to use it, and only net investment counts, because gross investment that merely replaces worn-out capital leaves capacity unchanged.

Other ways to work this

The same content, four other ways.

What is inside Levo

Six ways to work the same material.