Question

Consider the aggregate supply-aggregate demand (AS-AD) model. The long run AS curve (LAS) is considered to be vertical at the full employment level of income. Discuss briefly 2-3 practical ways how the long run AS curve can be affected (increased) by carrying out certain government policies! Are there any risks associated with an increase in the long run AS in your examples (please, briefly discuss the risks involved)?

Answer 1

Long run aggregate supply curve is vertical because it is unaffected by price level. Following factors are responsible to bring a rightward shift in LRAS

• Higher productivity(productivity shock) of labor and capital
• Improved technology
• increased human capital
• Increased labor force (immigration)
• Capital investment

Government can allow immigrants, so this will shift the LRAS to the right as the productive capacity / potential of the economy is increased. A danger of this policy is increased competition for food/shelter/jobs which is likely to increase aggregate demand as wellm leading to an inflationary gap.

Governnment can stimulate research and development which develops more effective technology that increases labor and capital productivity. This will shift the aggregate supply in the short run as well leading to deflation. This risk of inflation is then needed to be countered using expansionary policy.