2.3 Aggregate Supply

Question 1

What is AS?

Answer 1

The volume of goods and services produced within the economy at a given price level

Question 2

What is SRAS?

Answer 2

The relationship between planned national output and the general price level over a short time period

Question 3

Draw SRAS Curve

Answer 3

Question 4

Why is the AS curve upward sloping?

Answer 4

• If real output is increased firms will have to pay more for overtime or for faster delivery of raw materials.
• Higher prices for goods and services make output more profitable and enable businesses to expand production by hiring extra labour and other resources.

Question 5

What causes an expansion of AS?

Answer 5

A rise in the price level

Question 6

What causes a contraction of AS?

Answer 6

A fall in the price level

Question 7

What causes shifts in SRAS?

Answer 7

• Changes in resource input prices
• Business taxes, subsidies, regulations and imported costs
• Supply shocks

Question 8

Examples of changes in resource input prices

Answer 8

• Wage costs per unit of output
• Labour productivity
• Raw material prices
• Energy costs

Question 9

Examples of Business taxes, subsidies, regulations and imported costs

Answer 9

• VAT, environmental changes / employment taxes
• Changes in the scale and size of government subsidies to certain industries
• Business rates + costs of meeting business regulations and other laws
• Cost of imported components (affected by the exchange rate and fluctuations in world commodity prices)

Question 10

Examples of Supply shocks

Answer 10

• Natural disasters
• Political crisis (civil war)

Question 11

Why would the SRAS curve shift inward?

Answer 11

• Might have been caused by a rise in raw material prices, energy costs, unit labour costs or perhaps an increase in the cost of meeting business regulations.

Question 12

Why would the SRAS curve shift outward?

Answer 12

• Perhaps a decline in energy costs.

Question 13

What does LRAS represent?

Answer 13

The long run potential level of output in the economy

Question 14

What are the factors influencing LRAS?

Answer 14

• Higher productivity of Labour and Capital
• Increased labour Market Participation
• Gains from innovation and enterprise
• Capital investment

Question 15

Shifts in LRAS may come from..

Answer 15

• Changes in labour supply available for production (i.e. 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 allocation of factor 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

Question 16

Draw a classical LRAS curve

Answer 16

Question 16

Explain classical economists in terms of classical LRAS

Answer 16

• A group of economists who believed that the macroeconomy always adjusts rapidly to the full-employment level of output.
• The labour market and other markets for factors of production will adjust quickly.
• Workers will adjust their wage expectations and accept lower wages.
• There will no resulting unemployment.
• If the economy always converges rapidly on full-employment levels of output, no manipulation of aggregate demand can have any effect except on the price level

Question 17

Draw a Keynesian LRAS graph

Question 18

Explain Kenesian LRAS

Answer 18

• Where spare capacity is high then AS will be elastic
• As output increases the amount of spare capacity declines
• Possibility of diminishing returns in production
• Bottlenecks in supply of inputs and components
• Resource shortages as the economy approaches full employment e.g. Skilled labour becomes more scarce
• When AS becomes perfectly inelastic the economy is at full capacity (equivalent to being on the PPF boundary)

Question 19

Explain non-inflationary growth in LRAS Kenesian

Answer 19

• An outward shift in AD from AD1 to AD2 can be met without an increase in the price level because short run aggregate supply is highly elastic
• INITIAL PART OF GRAPH before curve

Question 20

Explain inflationary pressured growth in LRAS Kenesian

Answer 20

• An outward shift in AD from AD3 to AD4 causes a sharp rise in the general price level because AS is inelastic (i.e. output is close to fullcapacity levels)