AQA Specification focus:
‘Underlying economic growth is represented by a rightward shift in the long-run AS curve.’
Introduction
Economic growth is central to understanding macroeconomic performance. This section explores how underlying growth shifts the long-run aggregate supply (LRAS) curve and why it matters.
Understanding the Long-Run Aggregate Supply (LRAS)
The long-run aggregate supply (LRAS) curve shows the maximum potential output of an economy when all resources are fully employed. Unlike the short-run aggregate supply (SRAS), which reflects temporary cost conditions, LRAS is determined by fundamental, structural factors in the economy.
Long-Run Aggregate Supply (LRAS): The total output an economy can produce when operating at full employment, determined by the quantity and quality of its factors of production.
The LRAS curve is typically drawn as vertical in the classical model, representing that in the long run, output is fixed at the economy’s capacity level and unaffected by the price level.
Underlying Economic Growth
Underlying economic growth refers to sustained increases in an economy’s productive capacity over time. It is not the same as short-term demand-driven growth. Instead, it reflects deeper improvements in the factors of production and efficiency.
Key drivers of underlying growth include:
Labour supply and quality – increases in population, education, and training.
Capital stock – investment in machinery, infrastructure, and technology.
Productivity improvements – better use of resources, innovation, and efficiency gains.
Institutional quality – legal, political, and financial systems supporting enterprise.
LRAS Shifts and Economic Growth
A rightward shift of the LRAS curve represents an increase in the economy’s long-term productive potential. This means the economy can produce more goods and services without triggering inflationary pressure.
Conditions that Shift LRAS Rightward
Technological progress: innovation enhances productivity and efficiency.
Investment in capital: modern equipment and infrastructure expand capacity.
Education and training: a skilled workforce raises output potential.
Improved labour mobility: flexible labour markets allow efficient allocation of workers.
Entrepreneurship and enterprise: risk-taking and business development increase productive capacity.
Conditions that Could Limit LRAS Growth
Declining investment: reduces capital accumulation.
Brain drain or falling labour force participation: shrinks the effective workforce.
Institutional weaknesses: corruption, poor governance, or weak financial systems hinder efficiency.
Classical vs Keynesian Perspectives on LRAS
Classical Perspective
LRAS is shown as a vertical line.
Suggests the economy always tends toward full employment in the long run.
Rightward shifts of LRAS are the only way to achieve long-term growth.
Keynesian Perspective
LRAS is drawn as an upward-sloping curve that becomes vertical at full capacity.
At low levels of output, increases in AD can raise output without inflation.
Underlying growth shifts the curve right, expanding the range over which growth without inflation is possible.
Link Between Growth and LRAS Shifts
The relationship between economic growth and LRAS shifts is fundamental:
Without shifts in LRAS, long-term sustainable growth is impossible.
Demand-side policies may raise output temporarily, but without underlying improvements, inflation emerges.
Supply-side policies are crucial for shifting LRAS and maintaining growth.
Policy Implications
Governments aiming to achieve sustained growth must prioritise supply-side improvements. Key strategies include:
Education and training programmes to enhance human capital.
Tax incentives for investment to encourage capital deepening.
Infrastructure development to reduce bottlenecks.
Encouraging research and development (R&D) to foster innovation.
Labour market reforms to increase flexibility and participation.
Distinguishing Short-Run and Long-Run Growth
It is important to separate short-term fluctuations from underlying long-run growth:
Short-run growth may result from higher AD but does not shift LRAS.
Long-run growth requires permanent changes that increase potential output.
Underlying Economic Growth: The sustained increase in an economy’s productive capacity, represented by a rightward shift in the long-run aggregate supply curve.
This distinction is vital for evaluating economic performance. Policymakers must ensure that growth is not merely temporary but grounded in rising productive potential.
Evaluating the Impact of LRAS Shifts
Shifts in LRAS have wide-ranging implications:
Higher living standards: more goods and services per capita.
Non-inflationary growth: output can expand without price instability.
Greater international competitiveness: economies with strong LRAS growth can export more effectively.
Improved fiscal health: higher output leads to stronger tax revenues without increasing tax rates.
FAQ
A temporary rise in output, often due to increased aggregate demand, does not change the economy’s long-run productive capacity. It can lead to inflation if resources are fully utilised.
A rightward shift of the LRAS curve reflects a permanent increase in productive potential, allowing the economy to produce more without sustained inflationary pressure.
Investment in R&D fosters innovation, leading to more efficient production processes and the creation of new products.
This enhances productivity across industries, increases competitiveness, and raises the long-term capacity of the economy. As a result, the LRAS curve shifts rightward.
Human capital refers to the skills, knowledge, and health of the workforce.
A more skilled workforce uses resources efficiently.
Better education and training improve adaptability to new technologies.
A healthier workforce ensures higher participation rates.
These factors collectively increase the productive potential of the economy.
Yes, long-term negative changes can reduce productive potential:
Declining infrastructure investment
Emigration of skilled workers (brain drain)
Weak institutions or corruption
Reduced innovation and productivity growth
Such factors shift the LRAS curve leftward, representing reduced capacity.
Supply-side policies aim to improve efficiency and expand capacity. Examples include:
Tax incentives for investment
Deregulation to encourage enterprise
Funding education and vocational training
Infrastructure development projects
These measures boost the long-run productive capacity, shifting LRAS rightward.
Practice Questions
Explain what is meant by a rightward shift in the long-run aggregate supply (LRAS) curve. (2 marks)
1 mark for stating that it represents an increase in the economy’s productive capacity / potential output.
1 mark for explaining that this allows more goods and services to be produced without inflationary pressure.
Discuss two factors that might cause a rightward shift of the long-run aggregate supply (LRAS) curve. (6 marks)
Up to 2 marks for identifying factors (e.g., technological progress, education and training, investment in capital, improved labour mobility, institutional quality).
Up to 2 marks for explaining each factor in terms of how it increases productive capacity (e.g., technology raises productivity, education improves human capital).
Up to 2 marks for development, such as providing relevant context, linking to sustained economic growth, or noting limitations (e.g., brain drain reducing labour supply may offset gains).
(Maximum 6 marks: 2 marks per well-developed point across two factors.)
