3.2.8 Shifts of the AS curve over the long-run Notes

Shifts in the long-run aggregate supply occur when there is growth in the production possibilities of the economy:

1. If there is an increase in the production possibilities, the economy has grown its factors of production and so can produce more real output in the long-run (when there is full employment of resources).
2. Therefore, in the long-run, there is an increase in the real output an economy produces at all possible price levels.
3. This shifts the LRAS curve and the Keynesian AS curve.

Shifts in the LRAS curve

1. When there is an increase in the production possibilities of an economy, the LRAS curve shifts to the right (LRAS1→LRAS2) to a new potential output (Yp1→Yp2).
2. When there is a decrease in the production possibilities of an economy, the LRAS curve shifts to the left (LRAS1→LRAS3) to a new potential output (Yp1→Yp3).

Shifts in the Keynesian AS curve

1. When there is an increase in the production possibilities of an economy, the Keynesian AS curve shifts to the right (AS1→AS2) to a new potential output (Yp1→Yp2).
2. When there is a decrease in the production possibilities of an economy, the Keynesian AS curve shifts to the left (LRAS1→LRAS3) to a new potential output (AS1→AS3).

Determinants of aggregate supply over the long-run

1. While changes in the PL cause movements along the LRAS curve / Keynesian AS curve, changes in the production possibilities of the economy shift the curves.
2. The factors that change the production possibilities of an economy can hence be understood as the determinants of aggregate supply over the long-run.

The determinants of aggregate supply over the long-run covered in the IB curriculum are:

1. Changes in the quantity and/or quality of factors of production.
2. Improvements in technology.
3. Increases in efficiency.
4. Changes in institutions.

Changes in the quantity and/or quality of factors of production

Increase in the quantity and/or quality of factors of production → rightward shift in LRAS / AS

1. Factors of production refer to the resources used in the production process: land, labor, capital, and entrepreneurship.
2. If the quantity of factors of production increases (larger labor force, discovery of new resources, or increased capital stock...), the economy's production possibilities increases.
3. Similarly, improvements in the quality of factors of production (higher-skilled workers, better technology, or more efficient capital...) also increases the economy's productivity.
4. Since long-run aggregate supply represents the economy's potential output at full employment, an increase in the quantity and/or quality of resources increases the economy's potential output through a growth in production possibilities.
5. This shifts the LRAS curve / AS curve to the right (LRAS1→LRAS2 / AS1→AS2).

Decrease in the quantity and/or quality of factors of production → leftward shift in LRAS / AS

1. Factors of production refer to the resources used in the production process: land, labor, capital, and entrepreneurship.
2. If the quantity of factors of production decreases (shrinking labor force due to aging population or emigration, depletion of natural resources, or reduced capital stock...), the economy's production possibilities decreases.
3. Similarly, declines in the quality of factors of production (poorly educated workforce, outdated technology, or inefficient capital...) also decreases the economy's productivity.
4. Since long-run aggregate supply represents the economy's potential output at full employment, a decrease in the quantity and/or quality of resources decreases the economy's potential output through a decrease in production possibilities.
5. This shifts the LRAS curve / AS curve to the left (LRAS1→LRAS2 / AS1→AS2).

Improvements in technology

Improvements in technology → rightward shift in LRAS / AS

1. Technology refers to the methods and innovations used in the production of goods and services.
2. Advancements in technology improve the efficiency of production processes, allowing more output to be produced with the same quantity of resources.
3. Since long-run aggregate supply represents the economy’s potential output at full employment, technological improvements increase the potential output by enhancing productivity and so expanding the production possibilities.
4. This leads to a rightward shift in the LRAS curve / AS curve (LRAS1→LRAS2 / AS1→AS2).

Declines in technology → leftward shift in LRAS / AS

1. Technology refers to the methods and innovations used in the production of goods and services.
2. Declines in technology reduce the efficiency of production processes, causing less output to be produced with the same quantity of resources.
3. Since long-run aggregate supply represents the economy’s potential output at full employment, technological declines decrease the potential output by reducing productivity and so decreasing the production possibilities.
4. This leads to a leftward shift in the LRAS curve / AS curve (LRAS1→LRAS2 / AS1→AS2).

Increases in efficiency

Increases in efficiency → rightward shift in LRAS / AS

1. Efficiency refers to the ability to maximise output from a given set of resources with minimal waste.
2. Improvements in efficiency (better resource allocation, enhanced worker training, optimised supply chain management...) allow the economy to produce more output without requiring additional inputs.
3. Since long-run aggregate supply represents the economy’s potential output at full employment, improved efficiency increases the potential output by enhancing productivity and so increasing the production possibilities.
4. This leads to a rightward shift in the LRAS curve / AS curve (LRAS1→LRAS2 / AS1→AS2).

Decreases in efficiency → leftward shift in LRAS / AS

1. Efficiency refers to the ability to maximise output from a given set of resources with minimal waste.
2. Declines in efficiency (worse resource allocation, poorer worker training, sub-optimised supply chain management...) cause the economy to produce less output while using the same amount of inputs.
3. Since long-run aggregate supply represents the economy’s potential output at full employment, reduced efficiency decreases the potential output by worsening productivity and so decreasing the production possibilities.
4. This leads to a leftward shift in the LRAS curve / AS curve (LRAS1→LRAS2 / AS1→AS2).

Changes in institutions

1. When certain political or economic priorities shift, the production possibilities of an economy can change directly.
2. This can cause an increase in the economy's potential output, or a decrease.
3. Therefore, changes in institutions can shift the long-run aggregate supply curves in both directions.