Macroeconomics For Dummies®, uk edition Published by: John Wiley & Sons, Ltd

Shifting long-run aggregate supply (LRAS)

Although the PPF specifies the output mix – the kinds of goods being produced and in what proportions – LRAS is informative about the natural level of total output.

Economic growth means that the LRAS curve shifts to the right, because now the economy is able to produce more output sustainably.

From the production function and the definition of the natural level of output (see the earlier section ‘Deciding on output in the long run’), you

can identify two main sources of economic growth:


An increase in the available factors of production.


Better technology, represented by a ‘better’ production function :

that is, one able to turn the same quantity of inputs into more output.

In Figure 8-4, economic growth has shifted long-run aggregate supply from LRAS₁ to LRAS₂.

© John Wiley & Sons


Figure 8-4: Economic growth shifts LRAS.

A couple of things to note:

Although most of the time countries experience economic growth, the

natural level of output can also fall. An extreme example is when a country experiences war. At their worst, wars can lead to the destruction of a large amount of a nation’s capital stock (K) as well as its labour force (L).


The source of economic growth is important in determining the effect on living standards. For example, an increase in L due to population growth leads – through the production function – to economic growth. It’s unlikely to lead to higher living standards, however, because these depend on output per capita. Conversely an increase in K is likely to lead to higher living standards because it’s likely to increase per capita income (not just total income).


We can show the second point formally. Economists commonly assume that the production function is constant returns to scale (CRS):

In words, scaling up the inputs by a factor also scales up output by . For example, doubling the amount of capital and labour ( ) also doubles the amount of output.

The justification for this assumption is that if you’re able to produce a certain amount of output (Y) using a certain quantity of inputs (K, L), you should be able to replicate it if all your inputs are doubled (or tripled, or whatever!).

Setting gives:

This expression says that output per person is equal to an (increasing) function of capital per person.

You can write this more simply as

where y denotes output per person (Y/L) and k denotes capital per person (K/L). This expression is called the production function in intensive form. It tells you that output per person (and therefore average living standards) depends upon how much capital exists per person.

All other things being equal, an increase in L reduces k = K/L and so reduces y = f(k); whereas an increase in K increases k and so increases y. Equally, any improvement in technology f(.) also sees an increase in y.