2002 AP Macro Exam (Question 2)
I love this question as it is one of the best FRQ's to further your
understanding of the LRAS Curve.
1st. Understand that (potential real gross domestic production) is the boundary of the production possibility curve. (on the curve)
2nd. Understand that what increases/decreases the PPC does the same to the LRAS curve. (Population, Trade, Resources, Human Capital ,Technology (productivity, capital formation))
Past Blog Post on this subject/topic
(a) A decrease in the labor force participation rate. (Population)
If the population decreases there are less people to work (overall) and therefore LRAS will decrease. This is not to be confused with unemployment, which is a short-run view of idle resources and is inefficiency, not a reduction in potential)
(b) An increase in the government deficit following a reduction in personal income taxes. (Technology)
A reduction in personal income taxes is contractionary fiscal policy.
The increase in government deficits implies an increase in government spending which is expansionary.
Which one is more powerful and why?
A decrease in taxes will increase disposable income and increase consumption and investment and thus aggregate demand but some of that tax decrease will be saved and not spent and therefore will have a less of an effect than government spending.
Government spending will be consumed in its entirety and has a larger multiplier.
More importantly, government spending implies that some of that increase in investment will be toward capital formation, (ports, technology, equipment and factories) and therefore will increase the long-run aggregate supply/potential real gross domestic production.
Government spending will increase potential real gross domestic production thus increasing long-run aggregate supply.
(c) A decrease in the quantity of inputs needed to produce a unit of output. (productivity/technology)
A decrease in the quantity of inputs needed to produce a unit of output implies there has been an increase in technology/productivity. An increase in technology allows the production possibility curve boundary to shift outward and LRAS curve shifts rightward.
(d) An increase in the quality and quantity of education. (human capital)
Increases in the quality/quantity of education is an increase in human capital is a shifter of the PPC curve (outward) and therefore would cause the LRAS curve to shift rightward.
(e) An increase in the rate of savings.
An increase in the rate of savings means that the supply of loanable funds has increased which lowers the Real Interest Rate and spurs investment. Some of that investment will be capital formation and will shift the LRAS curve to the right.