2.3 Aggregate Supply (AS) Flashcards
Aggregate supply (AS) curve
Total volume of goods & services produced within the economy at a given price level
Indicates ability of an economy to produce goods & services
Reason for upward sloping curve of AS diagram
- firms are willing to supply more, but only at a higher price (incentive as higher profits)
- firms need to increase short term costs to increase short term output (fixed factors of production in short term so labour may have to work overtime so higher wages) passed onto consumer through higher prices
LRAS vs SRAS
SRAS = at least 1 factor of production is fixed & can’t be changed (money wage rates, prices of factors of production, state of technology), a change in these results in a shift of the SRAS curve
LRAS = all factors of production are variable
- in SRAS it’s possible for an economy to exceed maximum potential LRAS (factors of production work overtime), not possible in long run as machines will stop & workers will want a break
Factors influencing SRAS (cause change in cost of production)
- changes in costs of raw materials & energy
Increased = increased cost of production, left shift of SRAS curve (costs more to make same amount of goods, firms will only produce certain amount of goods if profit is lower) - changed in exchange rates
Weaker pound = increase in price of imports = left shift of SRAS curve (production more expensive) WIDEC
Stronger pound = cheaper imports = right shift of SRAS curve (more important goods, exports cheaper) SPICED - changes in tax rates
Increased taxes = increased cost of production = left shift of SRAS curve
Subsidies = decreased costs of production = right shift of SRAS curve
Different shapes of LRAS curve
- Classical
- Keynesian
LRAS overview
- in long run, AS is independent of price level & determined by the level of all factors of production & quality of technology
- LRAS is a measure of country’s potential output, concept linked to idea of PPF (production possibility frontier) = shows full capacity output (all resources are fully utilised)
Classical LRAS curve
- think markets tend to correct themselves fairly quickly
= although an economy can be in disequilibrium at any moment in time, it will naturally move towards equilibrium position YFE (all resources employed & economy producing at its productive potential on its PPF) = vertical curve
Why didn’t Keynesian agree with classical LRAS curve
- if LRAS curve is vertical = wages & prices fall when unemployment exists which makes it worthwhile employing people = employment increases = economy returns to full employment
Keynesian thought wages tend to be ‘sticky downwards’ = will not fall below a certain level as:
- unions able to prevent wages falling too low
- businesses unwilling to risk demotivation of staff by offering low wages
- workers unwilling to work unless certain wage is offered
- may be full employment in one area & unemployment in another area due to lack of labour mobility
- minimum wage means wages can’t fall below certain level
Keynesian LRAS curve
- horizontal line = high unemployment & firms want to recruit, don’t need to offer high wages to attract staff (LRAS price elastic)
- upward sloping curve = employment rises, less people looking for jobs & labour scarce enough that firms have to offer high wages to attract good workers = higher average price level (LRAS price inelastic)
- vertical curve = an increase in prices no longer affects output as the PPF (production possibility frontier) has been reached YFE (maximum potential output with current resources & tech)
The Keynesian AS curve is shaped due to the level of spare capacity available in the economy indicating that the economy can be in the long run at any level of output (Real GDP) due to the inflexibility of wages downwards. When there’s large level of spare capacity Keynesian believe that the output can increase without putting excess pressure on existing factors of production given the large amount of unemployed resources in the economy. Therefore Real GDP can increase without any demand pull inflationary pressure hence why the curve is horizontal at low levels of Real GDP.
§ Only when the economy approaches full capacity, Yfe, that for Real GDP to increase, pressure is put on existing factors of production increasing the price of them and thus costs of production for businesses- resulting In higher prices, increasing the inflation rate.
§ There comes a point when no spare capacity exists and thus Real GDP cannot increase without large increases in inflationary pressure, unsustainable production
Factors influences LRAS
- technological advances
- changes in relative productivity
- changes in eduction & skills
- changes in gov regulations
- demographic changes & migration
- competition policy
(Right shift of LRAS curve = economies able to produce more = same as outward shift of PPF (economic growth)) - through increased productivity or increased resources
Technological advances: Improvements in technology shift the LRAS curve to the right, meaning more can be produced- speeds up production= more goods can be produced with the same amount of resources. Increased investment in technology, whether this be new technology or current technology, will increase the LRAS as it means that more goods can be produced because there are more machines etc.
§ Changes in relative productivity- more productive the economy is, the more that will be produced with the given resources. Improvements in education and training can improve the human capital, skills and therefore labour productivity. This is an improvement in the quality of labour thus shifting LRAS to the right.
§ Changes in education and skills: skilled workforce = more employable - work quicker, efficiently – thus output per worker will increase- shift the LRAS to the right. Education can improve the occupational mobility of labour- decreases structural u/e as people are able to switch to new jobs. This will ensure all resources are used efficiently. a
§ Changes in government regulation: increase the size of the workforce- encouraging people to go back to work and decreasing the level of inactivity. Change the working age - expand the workforce as more people are able to work. Increasing the workforce will shift LRAS. Increased labour market participation. Government policy can increase research and development - offer tax breaks to businesses who invest money into research, encourages them improves productivity
§ Demographic changes and migration: If immigration is higher than emigration, the population will grow and so therefore there will be more workers which will increase the LRAS. The value and importance of this immigration will depend on the age of the immigrants and their skills. In an ageing population or a young population, LRAS will be lower as the working population is smaller so therefore fewer goods can be produced. The more people who are of working age, the higher the LRAS.
§ Investment- firms spending on new capital, upgrading machinery, improving tech, engaging in R&D. This improves the quantity and quality of the capital stock within the economy and also improves the productive efficiency, increasing LRAS1 to LRAS2
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§ Competition policy: government can promote competition between businesses and markets – forces them to improve the quality of their goods or lower prices. Businesses will have to improve their efficiency and this efficiency will mean that more goods and services can be produced, so LRAS will increase.
§ Infrastructure improvements- improve quality and quantity of the capital stock. Spending on transport, roads, airports reduces costs of production for firms, easier to transporting internationally becomes quicker, easier and more efficient- increases productive efficiency and boost competiveness.
Capital investment- including capital spending by business, inward investment from overseas FDI and public sector
§ Competition- any policies increasing competition for example privatisation deregulation and trade liberalisation will force firms to be as efficient as possible to keep costs and the prices as low as possible. This competitive drive will increase productive efficiency in the economy and increase LRAS1 to LRAS22
§ The institutional structure of the economy- key institutions such as banks and other financial intermediaries that bring together savers and borrowers perform a crucial role of accepting deposits and converting them into loans for entrepreneurs and business to fund investment (facilitating increase in the quality and quantity of the capital stock. A strong institutional structure in an economy will ensure persistent increases from LRAS1 to LRAS2
How technological advances influence LRAS
- improvement in tech = faster production = more goods can be produced with same amount of resources = right shift of LRAS curve
- investment in technology = more goods can be produced as more machines = right shift of LRAS curve
How can changes in relative productivity influence LRAS
- more productive economy (efficiency, skill of labour, tech) = more produced within given resources = right shift of LRAS curve
- more productive than other countries = encourage production of that good in this country = increased investment = right shift of LRAS curve
How can changes in education & skills influence LRAS
More skilled workforce = more employment & work quicker & more efficient = increased output per worker = right shift of LRAS curve
- can improve occupational mobility of labour = decreases structural unemployment = ppl can switch to new jobs in different fields = all resources used efficiently = right shift of LRAS curve
How can changes in gov regulations influence LRAS
- increase size of workforce (right shift of LRAS curve as more resources)
encourage ppl to work & decrease level of inactivity (free childcare for working mothers, reduce benefits
change the working age = more people able to work - increase research & development
offer tax breaks to businesses who invest money into research = firms have new ideas - improved productivity = right shift of LRAS curve - increase incentives to be entrepreneurial, easier to set up businesses (lower corporation tax) = increased companies, jobs, output, = right shift of LRAS curve
- high regulation on businesses = increased costs & increased time taken to undertake tasks = reduced output = left shift in LRAS curve
How can demographic changes & migration influence LRAS
- Immigration higher than emigration = population will grow = more workers = right shift in LRAS curve
- ageing / younger population = smaller working population (workforce) = less goods produced = left shift of LRAS curve
