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