aggregate supply

Question 1

What is Aggregate Supply?

Answer 1

Aggregate Supply is defined as the amount firms are willing to supply at any given price level.

Question 2

two types of AS

Answer 2

LRAS
SRAS

Question 3

what is SRAS

Answer 3

Short run aggregate supply (SRAS) shows total planned output when prices in the economy can change but the prices and productivity of all factor inputs e.g. wage rates and the state of technology are held constant.

Question 4

what is LRAS

Answer 4

long run aggregate supply (LRAS) shows total planned output when both prices and average wage rates can change – it is a measure of a country’s potential output and the concept is linked to the production possibility frontier

Question 5

stage a LRAS

Answer 5

Stage A
At this stage there is spare capacity in the economy (e.g. unused capital, unemployment). The economy can increase output without any cost pressures by simply employing the unused resources. At this point, a shift in the AD curve to the right would lead to an increase in output without increasing the price.

Question 6

stage b LRAS

Answer 6

At this stage, as the economy is approaching full capacity, supply starts to become more inelastic. The economy is near full capacity, so the cost of resources (e.g. labour) might rise, and so an increase in output will lead to a rise in price.

Question 7

stage c LRAS

Answer 7

At this stage the economy is at full capacity-­‐ the maximum level of output has been reached. All workers are employed, so if a firm wants to increase output it has to entice workers away from other jobs by offering higher wages. A shift in the AD curve to the right will lead to a rise in price and no increased output.

Question 8

Factors Influencing the Position of the AS Curve

The greater the productive capacity of a firm, the more it will supply at any given price level. For example, a small computer shop will supply fewer computers than a large computer store at a given price level.

Answer 8

level of investment
availability of factors of production
costs of production

Question 9

level of investment, how??

Answer 9

If investment is high, the productive capacity will increase and the efficiency of factor inputs will increase (leading to a fall in production cost). This will lead to a greater supply at any given price level-­‐ AS is higher.
Therefore, the higher the investment in the economy, the greater the quantity supplied at a given price level.

Question 10

availability of factors of production, how??

Answer 10

The more resources (factor inputs) there are in the economy, the greater the productive capacity, and hence the higher the aggregate supply.

The higher the quality of resources (factor inputs) in the economy, the greater the productive capacity, and hence the higher the aggregate supply.

Question 11

costs of production, how??

Answer 11

The higher the cost of production in the economy, the lower the aggregate supply (the further the AS curve is to the left).

If production costs are high, profits are reduced for firms so they supply less at any given price level-­‐ AS is lower.

If production costs are low, there are increased profit margins for firms, so they supply more at any given price level-­‐ AS is higher.

Question 12

which factors may shift the AS curve?

Answer 12

Changing Costs of Raw Materials
Exchange Rates
Change in International Trade
Technological Advances
Relative Productivity Changes
Education and Skills Changes
Regulation Changes
Interest Rates

Question 13

how can changing costs of raw materials shift AS curve

Answer 13

A global rise in the price of raw materials will lead to a rise in production costs, and hence a fall in LRAS.

The term ‘global’ means that prices increase around the world, not just due to a change in exchange rate in the UK.

Question 14

how can exchange rates shift AS curve

Answer 14

A rise in the exchange rate will reduce the price of imported raw materials, reducing production costs, and hence increasing LRAS.

For example, if the pound rose in value relative to the euro, imports will be cheaper and hence imported raw materials from the Euro-­‐zone will be cheaper for firms, so production costs fall.

Question 15

how can changes in international trade shift AS curve

Answer 15

As foreign countries open up to more trade, competition drives down prices and inefficient domestic firms give way to overseas firms. Imported raw materials therefore become cheaper for UK firms, production costs fall, and LRAS falls.

Question 16

how can technological advances affect AS curve

Answer 16

Technological advances increase the productive capacity of firms in the economy and also decrease production costs, leading to a rise in LRAS.

For example, technological advancements mean that book stores can now sell eBooks. The book stores save money in terms of printing, shipping and handling costs-­‐ so production costs fall. Also, the productive capacity of the stores increase-­‐ they can now supply unlimited numbers of books.

Question 17

how can relative productivity changes affect AS curve

Answer 17

Productivity is the output produced per unit of input.

If productivity of an economy increases relative to other economies, production costs for firms will decrease and the productive capacity of firms will rise. This will lead to a rise in LRAS.

Question 18

how can educational and skills changes affect AS curve

Answer 18

increased investment in education and skill will mean more people are able and willing to work in the economy-­‐ the supply of labour increases. Productivity of workers will also increase. Therefore, there is an increase in quality and quantity of labour, leading to an increase in LRAS.

However, the effect depends on what the money is invested in. Investment in primary schools will have a smaller effect on the workforce than investment in universities.

Question 19

how can regulation changes affect AS curve

Answer 19

Income Tax Level
A rise in income tax will reduce the opportunity cost of being inactive. More workers will leave work and become inactive, so the productive capacity of the economy decreases-­‐ LRAS decreases.

Question 20

how can regulation changes affect AS curve

Answer 20

Increase in Health Spending
An increase in health spending will reduce sick days and will mean that workers are active for longer-­‐ often beyond the traditional retirement ages. This increases the supply of labour. Better health of the workforce will also increase productivity of workers-­‐ quality of labour increases. Therefore the productive capacity increases and LRAS increases.

However, the effect on the workforce will be minimal if a large proportion of the money is spent on increasing the wages of doctors as opposed to improving the quality of healthcare. Also, the majority of healthcare spending goes on the elderly or youth, neither of whom are economically active.

Question 21

how can interest rates affect AS curve

Answer 21

A reduction in the bank will lead to increased investment in capital stock, leading to an increase in productive capacity and a fall in production cost-­‐ LRAS will increase.