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Macro Economics > 2.3 Aggregate Supply > Flashcards

2.3 Aggregate Supply Flashcards

1
Q

What is aggregate supply ?

A
  • the quantity of goods and services that producers in an economy are willing and able to supply at a given price level in a given time period
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2
Q

What is short run AS ?

A
  • the period of time in which at least one factor of production is fixed eg. capital
  • the relationship between planned national output (GDP) and the general price level ➡️ a rise in the general price level should stimulate an expansion of AS as businesses respond to the profit motive
  • SRAS is upward sloping ie. positive relationship between price level and real GDP
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3
Q

What are the differences between Keynesian and classical economic views ?

A
  • Keynesians do not tend to distinguish between short run and long aggregate supply, instead prefer to just consider “aggregate supply” as a whole ➡️ for Keynesians, there is just one AS curve.
  • Neo-classical economists do distinguish between the short run and the long run ➡️ Neo-classical
    economists will use a SRAS curve and a LRAS curve ie. two curves
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4
Q

Why is the SRAS curve upward sloping ?

A
  • higher prices make output more profitable + enable businesses to expand production by hiring extra labour and other resources
  • a fall in the price level causes a contraction of AS
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5
Q

How does spare capacity affect SRAS ?

A
  • when a business is not making full use of its available capacity, there are spare factors of production incl. land, labour & capital
  • when an economy has plenty of spare capacity, SRAS is elastic
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6
Q

What factors cause shifts in SRAS ?

A
  • changes in resource (input) prices eg. wages, raw materials
  • business taxes, subsidies, regulations and imported costs
  • exchange rate/cost of imported components
  • unexpected supply shocks (affect the price of raw materials)
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7
Q

Examples of changes in resource (input) prices ?

A
  • wage costs per unit of output e.g. arising from higher living wage
  • labour productivity eg. higher efficiency lowers unit costs
  • key raw material and component prices eg. glass
  • energy costs eg. the world price of oil or energy
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8
Q

Examples of changes in tax ?

A
  • VAT, environmental charges / employment taxes
  • changes in the scale and size of govt subsidies to certain industries
  • business rates + costs of meeting business regulations and other laws
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9
Q

How does exchange rates cause a shift in SRAS ?

A
  • if the exchange rate weakens, then imports will become more expensive, causing the price of
    imported raw materials and components to rise
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10
Q

Examples of supply shocks ?

A
  • hurricanes, tsunami or the effects of drought, flooding or political crisis/civil war ➡️ affects the price of raw materials
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11
Q

What may cause an inward shift in SRAS ?

A
  • rise in raw material prices
  • energy costs
  • unit labour costs/rise in wages (if wages rise in line with productivity then unit labour costs will not change and SRAS will not shift inwards)
  • increases in the cost of meeting business regulations
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12
Q

What may cause an outward shift in SRAS ?

A
  • rise in labour productivity
  • decline in energy costs
  • increase in labour force
  • technology
    🔔 anything making production more efficient
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13
Q

What external factors affect SRAS ?

A
  • commodity prices eg. world oil prices
  • volatile exchange rates
  • level of net migration
  • Import tariffs/quotas eg. the UK may face tariffs on imports from the EU depending on the terms of Brexit negotiations making harder to trade
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14
Q

What is long run AS ?

A
  • the period of time in which all factors of production are variable
  • represents that maximum possible output in an economy when all factors of production in an economy are fully and efficiently employed eg. firms have time to build a bigger factory and respond to changes in demand ➡️ maximum output level is independent of the price level
  • an outward shift in the LRAS curve shows an increase in potential GDP/output/productivity
  • the ability to produce goods and services to meet demand is based on the state of production technology and the availability and quality of factor inputs ➡️ independent of the price level in the economy
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15
Q

What factors cause an increase in LRAS ?

A
  • higher productivity of labour and capital (ie. a rise in output per person and increased efficiency of technology)
  • growing population and increase labour market participation ie. growing labour supply and rise in the no of people in paid work
  • gains from innovation and enterprise
  • capital investment ➡️ incl. capital spending by
    businesses, inward investment from overseas
    (FDI) and the Public Sector (Government)
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16
Q

What factors cause changes in a nation’s potential GDP (LRAS) ?

A
  • changes in labour supply ie. more people joining the labour force
  • changes in the stock of capital inputs (affected by the level of gross capital investment)
  • changes in the efficiency of inputs e.g. shifting resources from rural to urban areas
  • improvements in the quality of factor inputs/productivity of inputs
  • advances in the state of technology
  • improvements in institutions such as the banking system
17
Q

What factors influence LRAS ?

A
  • technological advances
  • changes in relative productivity
  • changes in education and skills
  • changes in govt regulations
  • demographic changes and migration
  • competition policy
18
Q

What is productivity ?

A
  • measures the efficiency of the production process - output produced per hour work
  • in the LR productivity is a major determinant of economic growth and inflation
19
Q

What is the significance of increased productivity ?

A
  • inflation: lower ➡️ unit costs falling, outward shift of AS if productivity is rising faster than wages
  • economic growth: higher ➡️ gains in AS, expansion of AD
  • unemployment: Lower in long run as real GDP growth rises
  • balance of trade: improved ➡️ more competitive exports
  • spare capacity: rise from extra capacity in short run ➡️ we can get more from existing factors of production
  • business investment: higher ➡️ business profits will have increased, giving them more resources to fund capital spending
  • govt fiscal balance: Productivity gains in government will help to reduce state spending ➡️ increased value for money
20
Q

What are the economic benefits of net inward migration ?

A

🔔 expect positive net inward migration to shift the LRAS curve outwards
- migrants provide fresh skills and higher labour productivity
- increase in the active labour supply ➡️ expanding a country’s potential output + lower unit labour costs
- driver of innovation and entrepreneurship
- positive multiplier effects if migrants find paid work
- reducing skilled labour shortages in growing industries
- remittances sent home by migrants add to the GNI of home nations ➡️ creating potential for rising exports
- tax revenues ➡️ legal immigrants in work pay taxes, likely to be net contributors to government finances

21
Q

What are the risks/costs from net inward migration ?

A
  • welfare costs ➡️ increasing cost of providing public services due to rising demand
  • increases pressure on govt spending
  • possible displacement of domestic workers
  • social tensions from the problems of integrating thousands of extra workers into local areas and regions
  • rising demand for housing which forces up property prices and housing rents for many groups in the
    population
  • poverty risk ➡️ migration may worsen the level of relative poverty in a society + many migrant workers have complained of exploitation by businesses that have monopsony power in a local labour market
22
Q

Evaluating the effects of labour migration ?

A

🔔 effects of migration are hard to quantify and much depend on:
- the types of people and their skills who choose to migrate from one country to another i.e. the human capital of migrants may be more significant in the long run
- the ease with which migrant workers settle into a new country and whether they find regular jobs
- whether a rise in labour migration stimulates extra capital spending by firms and by government e.g. in new schools, hospitals, and investment by retail businesses
- the dynamic effects of migration e.g. Gains in innovation and research from notable migrant entrepreneurs, scientists and other groups
- whether migrants decide to stay in the longer term or whether they regard it as temporary (e.g. to gain
qualifications, learn a new language)

23
Q

What are the main aims of competition policy ?

A
  • to promote competition between firms (should bring prices down for consumers + encourage innovation) - improve the efficiency of markets

🔔 UK competition policy is very much focused on protecting consumers

24
Q

What are the four main pillars of competition policy in the UK ?

A

🔔 effective competition policy should help to improve an economy’s LRAS / productive potential

  1. antitrust and cartels: involves eliminating (illegal) agreements that restrict competition, and any abuse of
    market power (i.e. anti-competitive behaviour such as price-fixing by firms that have significant market share)
  2. market liberalisation: involves introducing competition or contestability (i.e. increasing the probability of competition) in sectors that have previously been dominated by large monopolistic firms e.g. energy suppliers and retail banking ➡️ this can be achieved by using deregulation, privatisation, and breaking up markets into different sectors e.g. separating energy generation from energy supply
  3. state aid control: involves analysing the role of the state in supporting industries (perhaps via subsidies)
    to ensure that this does not overly distort competition
  4. merger control: involves investigating mergers between firms, or takeovers, to ensure that they do not
    end up having monopoly power and reducing competition
25
Q

How can technological advances have significant impacts on an economy’s LRAS ?

A
  • technology usually provides more capital, but it can also make existing factors of production more efficient or stimulate the growth of brand-new industries
  • there have been many significant technological advances that ultimately affected long-
    run growth rates throughout history eg. printing press/the airplane/assembly line
  • recent technological advances incl. AI/custom vaccines/3D metal printing/nuclear fission
26
Q

What are the possible advantages of automation ?

A
  • improved product quality ➡️ likely fewer mistakes will be made + precision may be improved
  • shorter working weeks for labour
  • rising productivity
  • safer working conditions
  • lower operating costs for businesses i.e. no ‘sick days, able to operate 24/7
27
Q

What are the possible disadvantages of automation ?

A
  • job loss for some workers (if their work is easily replicated by machines) ➡️ worried
  • initial large capital expenditure by businesses ➡️ may make it difficult for smaller firms to compete
  • possibility of reduced flexibility (if businesses are using specialist machinery)
  • possible risk of hacking
28
Q

How can training and education increase LRAS ?

A
  • as each worker is highly skilled ➡️ capable of
    producing more output
  • however some highly skilled workers might emigrate to other countries where they can receive higher pay ➡️ known as a ‘brain drain’ (although these workers may send remittances back to their home country to support families there)
29
Q

How does demographic changes affect LRAS ?

A
  • increased pressure on many sectors and service eg. social care, health care, transport, pensions and housing
  • BUT the longer working lives and growing population will increase the size and productive capacity of the workforce
  • increased community engagement and involvement in volunteering due to having more years to spend with family and friends
30
Q

Examples of demographic changes in the UK ?

A
  • rising number of single person households (over 40% by 2032)
  • number of births each year expected to level off at around 700,000 per year
  • by 2032 life expectancy for men will be 83 and 87 for women
  • ageing population: the no. of 65-85 year olds will rise 39% by 2032
  • people in the highest socio-economic class live 7 years longer than those in the lowest
  • 32% of men under 35 live with their parents compared to 20% of women
31
Q

What is the Keynesian AS curve ?

A
  • it is non-linear where the elasticity of AS is dependent in part on the amount of spare productive capacity at different stages of the economic cycle
  • tend to describe the elastic section (i.e. horizontal section) as being affected in a similar way to the SRAS used by Neoclassical economists, and the inelastic section (i.e. the vertical section) as being affected in a similar way to the LRAS used by Neoclassical
    economists
32
Q

Why is the Keynesian AS curve this shape ?

A
  • when spare capacity is high, AS will be elastic (that is, output can be increased without a significant change
    in the price level)
  • the elasticity of the AS curve falls as output increases i.e. it becomes increasingly more difficult to raise output
    o The amount of spare capacity declines
    o Possibility of diminishing returns in production
    o Bottlenecks in supply of inputs and components
    o Resource shortages as the economy approaches full employment e.g. Skilled labour becomes scarce
  • when AS is perfectly inelastic, an economy is at full capacity (equivalent to being on the PPF boundary);
    further increases in AD are purely inflationary in the short run with little extra real output
33
Q

Full employment/classical range on the Keynesian AS curve ?

A
  • when the AS curve become vertical, the economy has reached full-employment of factor resources and the price level has no impact on total output
  • shift of the AD curve in this range lead to changes in price level BUT no changes in aggregate output
  • some economists believe the economy will adjust to this fixed level of output if prices and wages can adjust quickly enough
34
Q

Intermediary range on Keynesian AS curve ?

A
  • shows where there is a trade off between more output and higher prices
  • in this section you have to accept inflation if you want more growth
  • the economy is approaching full employment so prices start to increase
    🔔 economy usually operates in this
35
Q

Keynesian range on Keynesian AS curve ?

A
  • shows where there is lots of spare capacity in the economy so that it is possible to increase output and employment w/o leading to price increase
    🔔 would happen during a major recession with high unemployment
36
Q

What are the differences between Keynesian and Neoclassical perspectives on the economy

A
  • Keynesian view VS Neoclassical view
  • markets do not always work perfectly ➡️ prices can be
    inflexible i.e. take time to adjust VS markets will work well, provided that the government does not intervene (prices are flexible and quickly adjust)
  • governments will need to intervene, using fiscal policy, when an economy is in recession VS the economy is self-correcting, even in recession, and so government intervention is not needed
  • “In the long run we’re all dead” VS it is important to consider both the short run and the long run
  • there is a trade-off between unemployment and
    inflation VS there is only a trade-off between unemployment and inflation in the short-run
  • unemployment can be persistent VS unemployment always returns to its ‘natural rate’
37
Q

Comparing SRAS and LRAS ?

A
  • SRAS: assumes that the level of capital is fixed ie. can’t build a new factory HOWEVER can increase existing factors of production eg. workers doing over time
  • LRAS: amount of capital can be increased so that the curve is determined by the size of the workforce, total capital, levels of education and labour productivity + not affected by price

Macro Economics (13 decks)

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