2.3 Aggregate Supply Flashcards
Aggregate Supply
Total volume of goods and services produced within the economy at a given price level over a given time period
Indicates ability of an economy to produce goods and services and shows relationships between real GDP and average price levels
AS Curve
Upward sloping
To increase supply, firms need to increase production
To increase production, firms need to upgrade capital goods, hire temporary labour or increase over time wage
=> Increase production cost
=> Increased supply leads to higher price to maintain profit margin
SRAS is elastic
LR and SR Relationship
SR is period of time when at least one factor of production is fixed and cannot be changed
Money wage rates, factor prices and state of technology are fixed and cannot be changed - change results in shift of curve
LR all factors of production are variable
Disagreements between economists on shape of LRAS
SRAS Factors
Changes in costs of raw materials and energy
Changes in exchange rates
Change in tax rates
Supply side shocks occur when there are significant changes in any of these factors
SRAS Factors
Changes in Costs of Raw Materials and Energy
Increase in costs of raw materials or energy leads to increase in costs of production
=> SRAS curve shifts left as it costs more to make same amount of good
=> Firms only produce same amount if prices rise
SRAS Factors
Changes in Exchange Rates
Weaker pound leads to increased price of imports
=> SRAS decrease as production becomes more expensive
Stronger pound => imports cheaper so SRAS increases
SRAS Factors
Changes in Tax Rates
Taxes increase cost of production
=> Fall in SRAS, shifting left
Subsidies shift curve to the right as they decrease production costs
LRAS Shapes
Types
Classical
Keynesian
LRAS Shapes
Classical
AS is independent of price level and is determined by the level of all factors of production and the quality of technology
LRAS is a measure of a country’s potential output
Shows full capacity output
SR allows economy to exceed maximum potential LRAS but this is not possible in LR
Vertical AS curve is based on classical view that markets tend to correct themselves fairly quickly
=> If economy is in disequilibrium, it will naturally move to equilibrium => LRAS is vertical ( | )
LRAS Shapes
If curve was vertical, wages and prices fall when unemployment exists
Fall in wages makes it worthwhile employing people so employment increases and economy returns to full employment
LRAS Factors
Keynesian
Factors why wages will not fall
Unions are able to prevent wages falling too low
Businesses are unwilling to risk demotivation of staff by offering low wages
Workers are unwilling to work unless a certain wage is offered
There may be full employment in one area and unemployment in another due to lack of labour mobility
Minimum wage means wages cannot fall below a certain level
LRAS Shapes
Keynesian
Keynes thought classical was true to an extent but wages tend to be sticky downwards and would not fall for a number of reasons
When there is high unemployment and a firm wants to recruit, they do not have to offer high wages to attract staff as LRAS is perfectly elastic
When slowly curving up, employment rises and less people are looking for jobs and labour is becoming scarce enough that firms have to offer higher wages to attract best workers => higher costs => inelastic price output until vertical where increase in prices has no effect in output as PPF has been reached
LRAS Factors
Technological advances Changes in relative productivity Changes in education and skills Changes in government regulations Demographic changes and migration Competition policy
LRAS Factors
Technological Advances
Improvements in technology shifts LRAS right meaning more can be produced
Improvements speed up production so more goods can be produced with same amount of resources
Increased investment in technology increases LRAS as it means there are more capital goods leading to increased production
LRAS Factors
Changes in Relative Productivity
More productive economy => more production with given resources
If production in a country is higher than others, investment increases => LRAS increases
LRAS Factors
Changes in Education and Skills
More skilled workforce is more employable and productive so output increases, shifting LRAS to the right
Education could also be used to improve occupational mobility of labour which decreases structural unemployment allowing all resources to be used efficiently increasing the LRAS
LRAS Factors
Changes in Government Regulations
Workforce size increase shifting LRAS right as more resources in economy so more can be produced
Policies can increase research and development through tax breaks and subsidies allowing businesses to reinvest, shifting LRAS right as productivity increases
Increase incentives to be entrepreneurial increasing companies, jobs and output => LRAS increase
High regulations limit LRAS so less regulations in place will increase output and LRAS
LRAS Factors
Demographic Changes and Migration
If immigration is higher than emigration, population will grow => more workers increasing LRAS
Value and importance of immigration depends on age and skills
Ageing or young population, LRAS is lower as working population is smaller => less goods can be produced
More people of working age => higher LRAS
LRAS Factors
Competition Policy
Government can promote competition forcing them to improve quality of goods or lower prices
Businesses have to improve efficiency in order to maintain profit
=> LRAS increases
Less competition can sometimes be beneficial if it encourages investment and innovation
Copyright laws mean new ideas cannot be copied encouraging businesses to do more research as they are only ones who will benefit
