2.3 Aggregate Supply

Question 1

Definition: Aggregate Supply

Answer 1

The total quantity of goods and services that firms are willing and able to produce at a given overall price level in a specific time period.

Question 2

Long Run vs Short Run

Answer 2

The long run refers to a time period in which all factors of production and factor input prices are variable.

The short run refers to a time period in which at least one factor of production (typically capital) is fixed.

Question 3

Factors affecting the LRAS curve

Answer 3

• Improvements in the quality and/or quantity of factors of production, increasing the productive potential of the economy and/or the capital stock, increasing spare capacity.
• Changes in regulation, the demographic and policy can also affect this.

Question 4

Factors affecting the SRAS curve

Answer 4

• The SRAS curve is only affected by changes in factors that instigate a change in the cost of production for firms, allowing them to produce more or less at each and every price level.
• Changes in material prices, exchange rates and taxation can also affect this

Question 5

The shape of the Keynesian LRAS curve

Answer 5

• The Keynesian LRAS curve is in an L-Shape
• The economy can operate below full capacity (at a negative output gap) in the long run.
• Real output can theoretically increase without a rise in the price level.
• Resources such as labour can still be unemployed without government intervention.
• When AD falls, wages are prevented from falling by unions and minimum wage, resulting in spare capacity in the long run as firms lay off workers and the labour market does not clear.
• There are bottlenecks in the LRAS curve when it starts to turn inelastic as supply chain issues come into play, increasing cost of production for firms
• When the curve is perfectly inelastic, there is no unemployment so any increase in AD would be inflationary.

Question 6

The shape of the Classical LRAS curve

Answer 6

• The Classical LRAS curve is perfectly inelastic.
• All resources are fully employed in the long run and all factors of production are fully utilised.
• The economy is operating at maximum output (no spare capacity)
• Any changes in AD would result in a reciprocating change in SRAS to return to equilibrium on the LRAS curve with some change in the price level but output remaining the same.
• (e.g. An increase in AD creates a positive output gap which creates derived demand for labour which results in wages and cost of production increasing, reducing SRAS)
• Real output is limited by the productive potential of the economy and is not impacted by the price level resulting in output being the same at all price levels (perfectly inelastic)