MONETARIST MODEL
In the monetarist model, the Long Run Aggregate Supply (LRAS) curve is perfectly inelastic because it represents the maximum amount of output that the economy can produce using all available resources in the long run, regardless of the price level.
According to monetarist theory, changes in the money supply affect only nominal variables, such as prices, but have no impact on real variables, such as output or employment, in the long run. Therefore, the LRAS curve is vertical, indicating that an increase in the money supply will only lead to a corresponding increase in prices, but not to any increase in output or employment in the long run.
In other words, while the Short Run Aggregate Supply (SRAS) curve is upward sloping because firms can increase output in response to higher prices in the short run, the LRAS curve is perfectly inelastic because it represents the economy’s long-run productive capacity, which is determined by factors such as technology, capital accumulation, and labor force growth, and not affected by changes in the money supply or price level.
The shifting outward of the LRAS, and thus an increase in Long-Run Potential Output, is a result of an increase in quantity and/or quality of our factors of production: land, labour, capital and enterprise. This could be a result of:
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Technological advancements: An increase in technology and innovation can increase the productivity of workers and capital, leading to an increase in potential output.
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Increase in capital stock: An increase in the amount of capital available for production, such as investment in new machinery or infrastructure, can increase potential output.
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Increase in labor force: An increase in the size or quality of the labor force can increase potential output.
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Education and training: Improvements in education and training can increase the skills and productivity of workers, leading to an increase in potential output.
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Improved institutional frameworks: Improvements in the legal and regulatory environment, as well as better governance, can increase investment and productivity, leading to an increase in potential output.
KEYNESIAN MODEL
The Keynesian LRAS curve reflects the idea that the level of potential output in the economy is influenced by both long-run and short-run factors, while the Monetarist LRAS curve assumes that the level of potential output is determined solely by long-run factors and is not affected by changes in the price level or aggregate demand.
The flat and upward slope of the Keynesian LRAS curve reflects the idea that changes in aggregate demand can affect the level of output and employment, as it is possible to have some unused capacity in the economy. This is because firms may not be willing or able to immediately increase output in response to higher demand due to factors such as sticky prices and wages or uncertainty about the future.
The shifting outward of the LRAS, and thus an increase in Long-Run Potential Output, is a result of an increase in quantity and/or quality of our factors of production: land, labour, capital and enterprise. This could be a result of:
-
Technological advancements: An increase in technology and innovation can increase the productivity of workers and capital, leading to an increase in potential output.
-
Increase in capital stock: An increase in the amount of capital available for production, such as investment in new machinery or infrastructure, can increase potential output.
-
Increase in labor force: An increase in the size or quality of the labor force can increase potential output.
-
Education and training: Improvements in education and training can increase the skills and productivity of workers, leading to an increase in potential output.
-
Improved institutional frameworks: Improvements in the legal and regulatory environment, as well as better governance, can increase investment and productivity, leading to an increase in potential output.