Shifting Aggregate Supply

Curve over the Long-run

Unit 9 - Lesson 6
Learning outcomes
● Define all terms in orange bold in section 9.5 (AO1)
● Explain that the Aggregate Supply curve shifts over the long term in the
Monetarist and Keynesian Model due to (AO2)
○ Change in the quantity or quality of the factors of production
○ Technological improvements
○ Changes in efficiency
○ Institutional Changes
○ Natural Rate of Unemployment
● Draw diagrams showing shifts in the LRAS (Monetarist) and the AS
(Keynesian) (AO4)
● Discuss the differing assumption of the Keynesian and Monetarist Model and
their implications for the economy and government policy (AO3)
Changes in Aggregate Supply over the Long Term
Potential Output

● Total quantity of goods and services produced in an economy when there is

“full employment” of the factors of production.
○ Increase in potential output indicates economic growth
■ Shift to the right of the Long-run Aggregate Supply or Aggregate
Supply curve
○ Decrease in potential output indicate negative economic growth (fall in
Real output)
■ Shift to the left of the Long-run Aggregate Supply or Aggregate
Supply curve
Factors that change Aggregate Supply over long term
Graph on the left illustrates an increase in potential output from the Keynesian
perspective. The graph to the right illustrates an increase in potential output
Monetarist view.
Factors that change Aggregate Supply over long term

Increases in the quantity of the factors of production

● If the quantity of the factors of production in an economy increase this will

result in an increase in the potential output.
○ For example, increase in the quantity of land when there are new oil
reserves discovered.

Increases in the quality of the factors of production

● If the quality of the factors of production in an economy increase this will

result in an increase in the potential output.
○ For example, more highly skilled or healthier workers results in increased
output resulting in economic growth and increase in potential output.
Factors that change Aggregate Supply over long term
Improvements in Technology
● Improved technology for production of output means that the factors
of production using this new technology can produce more output.
○ For example, workers who work with new and improved
manufacturing technology will be able to produce more output.
Increases in Efficiency
● When an economy makes better use of their scarce resources
(increased efficiency) can lead to an increase in output produced.
Factors that change Aggregate Supply over long term

Institutional Changes
● Increased efficiency from policy changes that make better use of an
economy’s scarce resources can lead to an increase in potential output.
○ For example, the degree of private ownership versus public ownership;
degree of competition in the economy; degree of quality government
regulation
Reductions in the Natural Rate of Unemployment (NRU)
● If the Natural Rate of Unemployment (NRU) decreases this signifies that
the economy is making better use of their scarce resources.
● This decrease in unemployment can lead to an increase in output
produced (economic growth).
Long term growth versus short term fluctuations
All the factor discussed on the previous
slides need an extended period of time to
influence the economy therefore it is
referred to as long term economic
growth.

Over long periods of time, most economies

experience positive economic growth.

Long term growth in the Business Cycle

showing increases in the potential output
(see graph to the right) corresponds with a
rightward shift of the LRAS and AS curve.
Long term growth versus short term fluctuations

Short term economic growth

Using the Business Cycle diagram, during

periods of expansion the economy is
achieving economic growth (increase in
Real GDP)

However, the expansion is usually

followed by a contraction or period of time
where an economy experiences negative
economic growth or decreasing Real
GDP.
Long term growth versus short term fluctuations
Short term Economic Growth Monetarist
● Can be caused by an increase in Aggregate Demand (AD)
○ Increase in Aggregate Demand result in an increase in Real GDP
(economic growth)
● Can be caused by an increase in the Short run Aggregate Supply (SRAS)
○ Increase in Short run Aggregate Supply (SRAS) result in an increase in
Real GDP (economic growth)
Short term Economic Growth Keynesian
● Can be caused by an increase in Aggregate Demand (AD)
○ Increase in Aggregate Demand result in an increase in Real GDP
(economic growth)
Short run Economic Growth does not involve an increase in potential
output.
Monetarist versus Keynesian Model
Monetarist Model

● The economy will self-correct

returning to the “full employment”
level of output through resource price
changes

Keynesian

● The economy can stay in a

Recessionary Gap for an extended
period of time due to the inflexible
wages in the downward direction.
Monetarist versus Keynesian Model
The two schools of thought have differing implication on the type of
government policy that should be introduce:
● Monetarist
○ Government should work to make markets as free as possible so that
wages and product prices can respond to supply and demand.
○ Minimal or no government intervention into the markets or economy
● Keynesian
○ Government must intervene in the market in order to help an economy
get out of a Recessionary Gap.