AQA Specification focus:
‘The fundamental determinants of long-run AS such as technology, productivity, attitudes, enterprise, factor mobility, and economic incentives.’
The long-run aggregate supply (LRAS) represents an economy’s productive potential when all resources are fully employed. Understanding its determinants is central to analysing long-term growth prospects.
What is Long-Run Aggregate Supply?
Long-run aggregate supply (LRAS) refers to the total output an economy can produce when operating at full employment, independent of the price level. It shows the economy’s productive capacity, influenced by the quality and quantity of factors of production and structural conditions.
Long-run aggregate supply (LRAS): The maximum sustainable output of an economy when all resources are fully utilised, determined by factor availability and efficiency.
LRAS is typically drawn as a vertical curve, indicating that in the long run, output is determined by supply-side factors rather than the price level.
The classical LRAS curve is depicted as a vertical line at the full employment level of output, reflecting the economy's productive capacity when all resources are fully utilised. Source
Technology and Innovation
Technology plays a critical role in shaping LRAS. Improvements in technological processes and capital goods increase productivity and efficiency, enabling the economy to produce more with the same resources.
Advancements in automation, digitalisation, and artificial intelligence raise output potential.
Investment in research and development fosters innovation, shifting the LRAS curve to the right.
Productivity: The efficiency with which inputs are converted into outputs, often measured as output per worker or output per hour worked.
Productivity and Efficiency
Increases in labour productivity enhance the productive potential of the economy. This can stem from better training, improved education systems, or the adoption of efficient work practices.
Higher productivity reduces unit costs of production.
Productivity growth sustains long-run economic expansion without inflationary pressure.
Attitudes and Cultural Factors
Attitudes toward work, enterprise, and innovation influence LRAS. Economies with a culture that values education, risk-taking, and innovation are more likely to experience supply-side growth.
A strong work ethic supports labour market participation.
Social attitudes toward gender equality and inclusion expand the effective workforce.
Cultural acceptance of entrepreneurship encourages new business formation.
Enterprise and Entrepreneurship
Enterprise refers to the ability of individuals to combine factors of production to create goods and services. Entrepreneurs drive innovation, generate employment, and respond to changing consumer demands.
Policies that support entrepreneurship, such as reduced red tape and improved access to finance, boost LRAS.
Dynamic business environments encourage competition and efficiency, enhancing supply-side growth.
Enterprise: The willingness and ability to organise resources to produce goods and services, often involving risk-taking and innovation.
Factor Mobility
Factor mobility determines how effectively labour and capital can be reallocated across sectors.
Labour mobility: The ability of workers to switch jobs, sectors, or geographic regions. Higher mobility reduces structural unemployment and allows resources to be allocated efficiently.
Capital mobility: The capacity for investment funds to flow to their most productive uses, domestically or internationally.
Improvements in education, retraining programmes, and infrastructure development support greater factor mobility, ensuring the economy adapts to structural changes.
The Keynesian LRAS curve illustrates how productive capacity can expand over time through improvements in technology, capital, and labour, leading to rightward shifts in LRAS. Source
Economic Incentives
Economic incentives influence the willingness of individuals and firms to work, invest, and innovate.
Taxation: Lower marginal tax rates may encourage work and investment, while excessively high taxes may discourage effort or risk-taking.
Welfare policies: Well-designed systems support those in need while maintaining incentives to work.
Profit motives: Firms are incentivised to innovate and expand when profit opportunities exist.
Labour Supply Incentive (LSI) = Post-tax Income – Welfare Support
Post-tax Income = Earnings – Tax
Welfare Support = Benefits received if not working
A higher LSI encourages greater participation in the labour force, increasing productive capacity.
Interconnected Determinants of LRAS
The determinants of LRAS are deeply interconnected:
Technology and productivity reinforce one another, as new technologies often drive efficiency gains.
Enterprise and innovation thrive where incentives are aligned and factor mobility supports resource reallocation.
Cultural attitudes shape the acceptance of entrepreneurship, gender equality in the workforce, and openness to innovation.
These combined factors explain why some economies experience sustained long-run growth while others remain stagnant.
Policy Implications
Governments influence LRAS through supply-side policies. Examples include:
Education and training investment to raise productivity and enhance labour mobility.
Infrastructure development to improve connectivity and reduce production costs.
Research and development subsidies to stimulate technological advancement.
Tax reforms to encourage investment and entrepreneurship.
Effective policy ensures that the economy’s productive capacity expands over time, shifting the LRAS curve rightward.
FAQ
Short-run aggregate supply (SRAS) is influenced mainly by production costs such as wages, raw materials, and taxation. These are variable in the short term.
Long-run aggregate supply (LRAS), however, depends on structural factors like productivity, technology, and labour force quality. These shape the economy’s maximum sustainable output and are not tied to day-to-day price changes.
When a society values education, more people pursue higher levels of training and qualifications. This raises the overall skill level of the workforce.
Skilled workers improve productivity.
Innovation is more likely with a highly educated population.
Greater adaptability of labour supports long-run growth.
This translates into an outward shift of the LRAS curve as the economy’s capacity expands.
Entrepreneurship drives innovation and competition, which are vital for increasing productive potential. Entrepreneurs introduce new products, processes, and technologies.
This leads to:
Greater efficiency in resource use.
Expansion of industries and job creation.
Encouragement of risk-taking and enterprise culture.
Without strong entrepreneurial activity, LRAS growth may stagnate even if resources are available.
Structural unemployment occurs when workers’ skills do not match available jobs. High labour mobility helps reduce this mismatch.
If workers retrain or relocate to different industries, resources are better allocated. Similarly, capital mobility ensures investment flows to productive sectors.
By minimising resource wastage, LRAS shifts outward, reflecting a more efficient economy.
Incentives influence choices made by households and firms.
Lower income taxes may encourage higher labour participation.
Business tax reductions can lead to greater investment in technology and capital.
Well-designed welfare systems can support people without discouraging work.
Sustained positive incentives raise productive capacity, gradually pushing LRAS to the right.
Practice Questions
Define long-run aggregate supply (LRAS). (2 marks)
1 mark for recognising that LRAS represents the maximum sustainable output of an economy when all resources are fully employed.
1 mark for stating that LRAS is determined by supply-side factors (e.g. productivity, factor availability, technology) and is independent of the price level.
Explain two factors that could cause the long-run aggregate supply (LRAS) curve to shift to the right. (6 marks)
Up to 3 marks per factor (maximum 6).
1 mark for identifying a relevant factor (e.g. improvements in technology, increased labour productivity, greater factor mobility, positive changes in attitudes, enterprise, or incentives).
1 additional mark for explaining how the factor increases productive potential.
1 further mark for linking the explanation to a rightward shift of the LRAS curve (e.g. demonstrating how it raises the economy’s capacity output or full employment level of output).
