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A-Level Economics · Keynesian LRAS (spare capacity) diagram question
The SAME increase in AD happens near full employment instead — AD₂ crossing at F. What does the economy get?
The diagram
The answer
Mostly inflation and very little extra output — an unfavourable growth/inflation trade-off. You have loads more demand but you have run out of people — so all you do is push up prices. Near capacity the curve is steep: output crawls from Y₁ towards Yfe while the price level climbs from P₁ to P₂. There are just no more workers, so extra demand bids up wages and the rental price of capital and feeds straight into prices. That is the growth-versus-inflation trade-off the examiner wants named — and after Covid, large stimulus into a supply-constrained economy is the real-world case.
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