Question

1. Name and briefly describe at least three determinants of an economy’s long-run level of output.

2.What do we call this specific long run level of output?

Answer 1

1. Since long run variables depend only on real variables and not nominal variables, thus the long run level of output is not affected by nominal rigidities such as sticky prices, sticky wages, imperfect information etx. Rather, it is determined by productivity, capital stock and size of the population.

(i) Productivity

An increase in productivity means we are able to produce greater output using the same level of inputs, and vice versa.

(ii) Capital stock

The size of the capital stock determines the level of savings, which is the market for loanable funds.

(iii) Size of the population/labour supply

How many hours a person desires to work also determines the real wage.

2. This specific long run level of output is called the natural level of output, and in the long run, the economy always returns to its natural level of equilibrkum.