2.3 Aggregate Supply Flashcards
What is aggregate supply ?
- 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
What is short run AS ?
- 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
What are the differences between Keynesian and classical economic views ?
- 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
Why is the SRAS curve upward sloping ?
- 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
How does spare capacity affect SRAS ?
- 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
What factors cause shifts in SRAS ?
- 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)
Examples of changes in resource (input) prices ?
- 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
Examples of changes in tax ?
- 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
How does exchange rates cause a shift in SRAS ?
- if the exchange rate weakens, then imports will become more expensive, causing the price of
imported raw materials and components to rise
Examples of supply shocks ?
- hurricanes, tsunami or the effects of drought, flooding or political crisis/civil war ➡️ affects the price of raw materials
What may cause an inward shift in SRAS ?
- 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
What may cause an outward shift in SRAS ?
- rise in labour productivity
- decline in energy costs
- increase in labour force
- technology
🔔 anything making production more efficient
What external factors affect SRAS ?
- 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
What is long run AS ?
- 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
What factors cause an increase in LRAS ?
- 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)
What factors cause changes in a nation’s potential GDP (LRAS) ?
- 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
What factors influence LRAS ?
- technological advances
- changes in relative productivity
- changes in education and skills
- changes in govt regulations
- demographic changes and migration
- competition policy
What is productivity ?
- 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
What is the significance of increased productivity ?
- 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
What are the economic benefits of net inward migration ?
🔔 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
What are the risks/costs from net inward migration ?
- 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
Evaluating the effects of labour migration ?
🔔 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)
What are the main aims of competition policy ?
- 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
What are the four main pillars of competition policy in the UK ?
🔔 effective competition policy should help to improve an economy’s LRAS / productive potential
- 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) - 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
- 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 - merger control: involves investigating mergers between firms, or takeovers, to ensure that they do not
end up having monopoly power and reducing competition
How can technological advances have significant impacts on an economy’s LRAS ?
- 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
What are the possible advantages of automation ?
- 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
What are the possible disadvantages of automation ?
- 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
How can training and education increase LRAS ?
- 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)
How does demographic changes affect LRAS ?
- 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
Examples of demographic changes in the UK ?
- 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
What is the Keynesian AS curve ?
- 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
Why is the Keynesian AS curve this shape ?
- 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
Full employment/classical range on the Keynesian AS curve ?
- 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
Intermediary range on Keynesian AS curve ?
- 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
Keynesian range on Keynesian AS curve ?
- 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
What are the differences between Keynesian and Neoclassical perspectives on the economy
- 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’
Comparing SRAS and LRAS ?
- 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
