2.3- Aggregate Supply Flashcards
What is Aggregate supply?
Aggregate supply is the total supply of goods/services produced within an economy at a specific price level at a given time
What is the distinction between long run and short run?
Long-run: all factors of production are variable
Short-run: at least one factor of production is fixed e.g. capital
What causes a movement along the SRAS curve?
Whenever there is a change in the average price level (AP) in an economy, there is a movement along the short run aggregate supply (SRAS) curve
Expansion - shifts up
Contraction - shifts down
What is Short run aggregate supply (SRAS)?
(define short-run)
- Short run aggregate supply (SRAS) is influenced by changes in the costs of production, but overall productive capacity remains unchanged
- Short run refers to the time period where at least one factor of production is fixed,e.g. capital
What is Long run aggregate supply (LRAS)?
- Long run aggregate supply (LRAS) shows the productive potential of firms when all factors are variable
- Influenced by a change in the productive capacity of the economy
- Productive capacity is changed by changes to the quantity or quality of the factors of production
What factors influence SRAS?
- Changes in costs of raw materials and energy
- Changes in exchange rates (E/R)
- Changes in tax rates
What is the classical view of LRAS?
- In the long-run an economy will operate at full capacity and there will be no unemployed resources
- If there are any unemploymed resources, the prices of these factors will fall until the surplus disappears
- LRAS is perfectly inelastic (vertical) at a point of full employment of all available resources
What is the classical view of what will happen in the short-run (LRAS)?
There may be short-run output gaps in the economy:
- During extreme periods of economic growth there can be an inflationary gap that develops
Will self-correct in the long-run and return to long-run level of output, but at a higher average price level
- During slowdowns or recessions there can be a recessionary gap that develops
Will self-correct in the long-run and return to the long-run level of output, but at a lower average price level
What is the Keynesian view of LRAS?
- The equilibrium level of output can occur below the YFE level of output
- Believed LRAS was L shaped
- Supply is elastic at lower levels of output as there is a lot of spare capacity in the economy
- Struggling firms will increase output without raising prices
- Supply is perfectly inelastic (vertical) at a point of YFE of all available resources - the closer the economy gets to this point, the more price inflation will occur as firms compete for scarce resources
- An economy will not always self-correct and return to YFE - it can get stuck at an equilibrium well below the full employment level of output e.g. Great Depression
- There is role for the government to increase its expenditure so as to shift AD and change the negative ‘animal spirits’ in the economy
What factors influence LRAS?
- Technological advances: these often improve the quality of the FOP e.g. development of metal alloys
- Changes in relative productivity: process innovation often results in productivity improvement e.g. moving from labour intensive car production to automated car production
- Changes in education and skills: over time this increases the quality of labour in an economy
- Changes in government regulations: these can improve the quantity of the factors of production. e.g. deregulation of fracking (extracting oil from shale deposits) increased oil reserves
- Demographic changes and migration: a positive net birth rate or positive net migration rate will increase the quantity of labour available
- Competition policy: regulating industries so as to prevent monopoly power results in more firms supplying G&S in an economy - increases the potential
output of an economy
