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A-Level Economics · Keynesian LRAS (spare capacity) diagram question

EVALUATION: a supply-side policy shifts LRAS right while the economy is stuck at E on the flat range. What happens?

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The diagram

The answer

Almost nothing — potential output rises but actual output is held down by weak demand, so the spare capacity just gets bigger. Supply-side policy only raises the ceiling. In a lockdown you need more pub-goers, not more pubs. Supply-side policy raises POTENTIAL output; on the flat range actual output is constrained by demand, so the gap between the two simply widens. During Covid the government ran Eat Out to Help Out — building more pubs would have been the wrong answer, because the shortage was demand, not capacity. Demand-side problems need demand-side solutions. Putting this evaluation on a diagram is what separates the best students.

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