2.3 - Aggregate Supply Flashcards
Define aggregate supply.
Aggregate supply (AS) is the total volume of goods and services at any given overall price level in an economy.
Describe short-run AS.
In the short run, the economical factors of production (land, labour, capital and entrepreneurship) are all constant. An exception however, is labour as firms can hire new labour or work existing labour. If firms were to increase their real output, then they could make their workers work overtime, increasing their pay to help incentivise the workers. To pay for this overtime wages, the firms would have to raise price level of goods and services.
Give the shape of the short run aggregate supply curve.
The short-run aggregate supply curve will be price elastic as it will be hard to cut costs while attempting to contract real output.
How would a rise in AD influence real output and the price level?
If AD were to increase, then the shift to the right in the AD curve would result in a rise in excess demand. Therefore, the price level would also be raised by the company from P to P1 as this would help pay for overtime workers and also increase real output.
How would a fall in AD influence real output and the price level?
If AD were to fall, then the AD curve will shift to the left from AD to AD2, resulting in excess supply. Excess supply here indicates that the firm has too much real output, so the firm will decrease real output from Y to Y2 and lower the price level from P to P2.
How would the SRAS curve shift?
The SRAS curve could shift to the left if production costs were to increase, or the SRAS curve could shift to the right and SRAS will rise if production costs decreased.
Describe movements along the SRAS curve.
Similar to microeconomics, for the short-run aggregate supply there can be a movement along the SRAS curve in the form of an expansion in SRAS or a contraction. AD can be a big influence in this; if AD were to rise, firms would spot an excellent opportunity to incur profits so they would immediately take advantage. This could be hiring new labour, working existing labour and resources to increase supply and get those profits.
What is an expansion in SRAS?
An expansion in SRAS is caused by a rise in the price level.
What is a contraction in SRAS?
A contraction in SRAS is caused by a fall in the price level.
Define the long run AS.
In the long run, all factors of production are now variable and can be increased over time. The LRAS measures the maximum possible output an economy can produce, taking into account its available land, labour, capital and entrepreneurial resources.
Give a factor of SRAS.
Production costs of raw materials and energy - If production costs of raw materials and energy were to rise, it would be more expensive to obtain the raw material so it will be harder to produce that good or service. This will shift the SRAS curve to the left from SRAS to SRAS2. As a result, the real output falls, quantity supplied falls while equilibrium price rises.
Describe another factor of SRAS.
Change in exchange rates - If the currency were to rise, this would mean it would convert to a cheaper local currency, so imports to the country would be cheaper. Therefore, SRAS will shift to the right from SRAS to SRAS1. But in the long term, the stronger currency would make the exports more expensive so AD from foreign buyers will fall. This makes LRAS decrease.
Give a third factor of SRAS.
Changes in tax rates - If direct taxes such as corporation taxes were to rise, this would increase the costs of production of a firm. This leads to a fall in SRAS, shifting the SRAS curve to the left from SRAS to SRAS2. Also, real national output will fall from Y to Y2, as well as price level. Typically large firms tend to relocate to an area of smaller taxation, when faced with large taxes.
What is the classical view of LRAS?
Classical economists tend to assume that markets will always function efficiently in the long term of an economy, producing maximum output of resources on the outer boundary of the production possibility curve. This is why the LRAS curve is vertical and perfectly inelastic, helping to mark the maximum limit of production.
Describe a shift in the LRAS curve.
Unlike SRAS, LRAS is more focused on the quantity and/or quality of factors of production as opposed to production costs. If the quantity or quality of factors of production were to rise, this would shift the LRAS curve to the right (from LRAS to LRAS1), whereas if quality or quality fell then the LRAS curve would shift to the left from LRAS to LRAS2.
