Aggregate Supply 2.3

Question 1

Define Aggregate supply

Answer 1

Aggregate supply is the volume of goods and services produced within economy at a given price level.

It indicates the ability of an economy to produce goods and services and shows the relationship between the real GDP and the average price level.

Question 2

Why is the SRAS curve upwards sloping?

Answer 2

The average and marginal cost of labour per good produced will rise as the business is paying more wages for every good they produce (in the short run, in order to increase production, firms need to increase the hours of work their employees do). This would be passes on to the consumer in the terms of increased prices and there only needs to be rising prices in some sectors for the price level of the economy to rise. Therefore, the curve is upwards sloping as firms are willing to supply more but only at a higher price.

Question 3

Why is SRAS likely to be elastic?

(i.e. output is relatively responsive to a change in price).

Answer 3

An increase in output by firms is likely to lead to an increase is costs which leads to a rise in prices as firms pass these costs onto consumers.

However, because the factor prices are constant, the increase in prices will be relatively small.

So, for example, if demand falls firms will react by cutting prices in an attempt to stimulate sales. However, firms will not not be able to achieve much of reduction in prices because of constant prices and an unwillingness in the short run to lay off workers.

Question 4

Define short run

Answer 4

Short run is the period of time when at least on factor of production is fixed and cannot be changed.

Question 5

Define long run

Answer 5

Long run is when all factors of production are variable.

Question 6

What is the main cause of a shift in SRAS?

Answer 6

The main cause of a shift in SRAS is a change in the cost of production.

Question 7

How can a change in the cost of raw material and energy cause a shift in SRAS?

Answer 7

An increase in the cost of raw materials and energy increase the costs of production. This means the SRAS curve will shift left as it will cost more to make the same amount of of goods and therefore business will only produce this amount of goods if prices rise.

Question 8

How can changes in the exchange rate cause a shift in SRAS?

Answer 8

A weaker pound will lead to an increase in the price of imports and this will cause SRAS to shift left as production becomes more expensive.

If the pound becomes stronger, imports will be cheaper and so SRAS will increase.

Question 9

How are changes in the exchange rate particularly important for the UK?

Answer 9

The UK is heavily dependent on imports. For example, the inflation the UK experienced after Brexit was caused by a fall in the pound, which pushed import prices up and led to cost-push inflation.

Question 10

How do changes in tax rates cause a shift in SRAS?

Answer 10

Taxes increase the cost of production and thus they cause a fall in SRAS, shifting it to the left. Subsidies shift the curve to the right as they decrease costs.

Question 11

What are supply side shocks?

Answer 11

Supply-side shocks occur when there are significant changes in factors that change the cost of production (changes in costs of raw materials and energy, changes in exchange rates, changes in tax rates).

Question 12

What are the characteristics of LRAS?

Answer 12

-LRAS is independent of price level

-LRAS is determined by the level of all factors of production and the quality of technology.

Question 13

Explain the vertical AS curve.

Answer 13

The vertical AS curve is based on the classical view that market tend to correct themselves fairly quickly. This means although an economy can be in disequilibrium at many moments in time it will naturally move towards the equilibrium positions where all resources are employed and the economy is producing at its productive potential. Therefore, LRAS is vertical.

Question 14

What does of shift LRAS to the right mean?

Answer 14

A shift of LRAS the the right means that economies of scale are able to produce more and is the same as outwards shift of the PPF.

Question 15

How can technological advances cause a shift in LRAS?

Answer 15

Improvements in technology shift the LRAS to the right, meaning that more can be produced. This is because it will speed up production, so more goods can be produced with the same amount of resources.

In parallel, increased investment in technology will increase LRAS as it means more goods can be produced because there are more machines etc.

Question 16

How do changes in relative productivity cause a shift in LRAS?

Answer 16

The more productive an economy is, the more that will be produced with the given resources.

Additionally, if the UK is more productive than other countries it will encourage production of good/services in the UK, so investment will be increase, shifting LRAS to the right.

Question 17

How do changes in education and skills cause a shift in LRAS?

Answer 17

A more skilled workforce will be more employable and work quicker and more efficiently within their jobs, so output per worker will increase, which will shift LRAS to the right.

Education can be used to improve the occupational mobility of labour which decreases structural unemployment as people are able to switch to new jobs. This will ensure all resources are used efficiently.

Question 18

Changes in government regulation can increase the size of the workforce, how does this cause a shift in LRAS?

Answer 18

The government can increase the size of the workforce by encouraging people to go back to work and decreasing the level of inactivity. For example, stay at home mums can be enticed back to work by free childcare at pre-school.

Also, the government can reduce unemployment by reducing benefits, which will encourage those living off benefits to find a job.

This causes LRAS to shift to the right because it means there are more resources in an economy and so more can be produced.

Question 19

Changes in government regulation can lead to increase in research and development, how does this cause a shift in LRAS?

Answer 19

Governmental policy can increase research and development as they can offer tax breaks to businesses who invest money into research, which will encourage them to do so. If a business able to come up with innovative ideas through R & D, it will increase LRAS as it will improve productivity.

Question 20

How can demographic changes and migration cause a shift in LRAS?

Answer 20

If immigration is higher than emigration, the population will grow and so therefore there will be more workers which will in turn cause LRAS to shift to the right.

However, the value and importance of immigration will depend on the age of immigrants and their skills.

Furthermore, if there is an ageing population or a young population, LRAS will be lower as the working population is smaller (less people who are economically active) so therefore less goods are produced.

Question 21

The government can promote competition between businesses and markets, how does this cause a shift in LRAS?

Answer 21

If the government promotes competition between businesses and markets it will force them to improve the quality of their goods or lower prices.

In order for a business to to this and still make a profit, they have to improve their efficiency and this efficiency will means that more goods and services can be produced, causing LRAS to shift to the right.