2.3 Aggregate Supply Flashcards
Aggregate supply
The total value of goods and services that producers in an economy are willing and able to supply at a given price level.
Short Run Aggregate Supply (SRAS)
Shows how much output an economy can generate in the short-term at each price.
Long run aggregate supply (LRAS)
Represents the maximum output that can be produced in an economy when all factors of production are fully and efficiently employed.
LRAS is like a PPF curve.
SRAS slopes upwards because
At a higher price level firms can make more profit so are willing to produce more.
Factors influencing SRAS
Changes in costs of raw materials: if the cost of electricity rises, the cost of production of almost everything also rises, meaning that AS decreases.
Change in exchange rates: Generally a stronger currency will reduce costs of production for firms and a weaker currency will increase them. (SPICED/WPIDEC)
Change in tax rates/subsidies: if there is a reduction in employers’ national insurance contributions then the costs of firms fall and the SRAS curve shifts to the right.
Change in the level of tariffs (taxes on imports): if a country increases tariffs on imports then the costs for domestic firms rise. This causes a leftward shift in the SRAS curve.
Other factors that can affect firms costs of production and shift SRAS
- Property / Land prices - changes to mortgage costs or property prices can impact firms costs
. - Interest rates - can affect firms borrowing costs and mortgage.
- Labour Productivity - if productivity improves, firms unit costs of production fall and they may be able to lay off some members of the workforce reducing overall labour costs.
Supply shocks
Supply shocks affect SRAS and can also affect a country’s LRAS potential.
Example of supply shocks might include:
- Steep rise in oil and gas prices or other commodities used in production.
- Political turmoil / civil unrest / major strikes
- Supply shut-downs caused by public health crisis
- Natural disasters causing a sharp fall in production
- Unexpected breakthroughs in production and technology
LRAS - classical approach
LRAS is assumed to be vertical - in the classical approach the economy is self-adjusting if markets are free from government intervention. If there is unemployment, wages fall until people can find work and full employment is restored.
LRAS - Keynesian approach
LRAS curve is curved- in the Keynesian approach the economy may be in equilibrium with unemployment, and governments may need to stimulate AD to achieve long term growth and employment.
This suggests that part of the LRAS is elastic whilst there is ever spare capacity in the economy but then becomes inelastic as space capacity runs out.
Spare capacity
When there are unused factors of production in the economy
Factors influencing LRAS
Technological advances: new robotics technology, for example, can reduce cost for a broad range of firms, causing rightward shift in the LRAS curve.
Relative productivity changes: productivity is defined as output per unit of input. If there is an improvement in productivity, the LRAS curve shifts to the right.
Education and skills changes: if more people are well educated then LRAS increases.
Changes in government regulations: if the government introduces laws to reduce environmental pollution that require firms to change technology then the LRAS may shift to the left if the laws cause a reduction in productive potential of the economy.
Demographic changes and migration: demographic changes have a direct effect on the supply, skills and cost of labour, and therefore impact on LRAS.
Competition policy: if the government makes new laws to make it easier to set up and run businesses, then LRAS is likely to increase.
Changes in minimum wage: an increase in the minimum wage can increase costs for firms, meaning that SRAS falls. However, there is evidence that increasing minimum wages can increase the productivity of workers, which might mean that LRAS increases.
Keynesian argue output can be below full capacity for various reasons:
- Wages are sticky downwards (labour markets don’t clear)
- Negative multiplier effect. Once there is a fall in AD, this causes others to have less income and reduce their spending creating a negative knock-on effect.
- A paradox of thrift. In a recession people lose confidence and therefore save more. By spending less this causes a further fall in demand.
- Keynesian argue greater emphasis on the role of AD in causing and overcoming recession.
Difference in policy recommendations
- Government spending
