Aggregate supply

Question 1

Define aggregate supply.

Answer 1

Aggregate supply is the level at which all firms are prepared to supply at given price levels.

Question 2

On what is aggregate supply based? - What does this incorporate? (4)
What happens as prices rise?

Answer 2

Aggregate supply is based on the costs of production, incorporating:

1) Rent
2) Wages
3) Interest
4) Profits

As prices rise, firms are willing to supply more, until the point of maximum capacity at which they are unable to supply anymore.

Question 3

What will happen if the cots of production rise?

Give an example.

Answer 3

If the cots of production rise, the AS curve will shift to the left.

For example, if the price of oil rises, firms will be unwilling to supply unless they can receive more money for the same output.

Question 4

What is spare capacity?

Answer 4

Spare capacity is said to exist in an economy when an economy has the ability to increase production without significant costs to firms. This means that resources are unused, and may mean there is unemployment.

Question 5

What is the Keynesian view of aggregate supply?

Answer 5

They Keynesian view of aggregate supply is reflective of the fact that there can be equilibrium and spare capacity in the economy.

Question 6

What is the classical approach to aggregate supply?

Answer 6

The classical approach to aggregate supply is reflective of the view that of there is spare capacity in the economy, it cannot be said to be in equilibrium and eventually the spare capacity will disappear, meaning that in the long run aggregate supply is vertical.

Question 7

When do movement along the supply curve occur?

What happens if there is an increase in AD?

What happens if there is a decrease in AD?

Answer 7

Movements along the supply curve occur when aggregate demand shifts and the price level changes.

If there is an increase in aggregate demand, aggregate supply will extend and firms will produce more.

If there is a decrease in aggregate demand, aggregate supply will contract, and firms will produce less.

Question 8

Why does aggregate supply shift?

Answer 8

If costs to firms increase, there is a decrease in aggregate supply.

If costs to firms decrease, there is an increase in aggregate supply.

Question 9

What factors may cause a shift of aggregate supply in the short run? (4)
Explain how these factors bring about the shift in AS.

Answer 9

1) Change in costs of raw materials, if the costs of oil rises the costs of production of almost everything will increase, meaning that aggregate supply decreases.
2) Change in the level of international trade, if trade in inhibited by a tax on imports, costs for domestic firms will tend to rise, as they are unable to enjoy low production costs by using cheap raw materials.
3) Change in the exchange rate, if the pound gets stronger, imports become cheaper and aggregate supply increases.
4) Change in tax rates, if there is a cut in an indirect tax such as VAT, you would expect AS to rise.

Question 10

What factors may cause a shift in aggregate supply in the long run? (7)

Answer 10

1) Technological advances
2) Relative productivity changes
3) Education and skill changes
4) Demographic changes
5) Competition policy and regulation
6) Changes in the minimum wage
7) Changes in the tax an benefit system

Question 11

Explain how technological advances affect aggregate supply in the long run.

Answer 11

New technology can reduce costs for firms.

Question 12

Explain how relative productivity changes can affect aggregate supply in the long run.

Answer 12

Productivity is defined as output per unit of input. If there is an improvement in the division and workflow becomes more efficient, then there will be an increase in AS.

Question 13

Explain how education and skill changes affect AS in the long run.

Answer 13

If more people are well educated, then aggregate supply increases.

Question 14

Explain how demographic changes and migration affect AS in the long run.

Answer 14

Demographic changes have a direct impact on the supply, skills and cost of labour, and therefore impact on aggregate supply as a whole.

Question 15

Explain the effect of migration in the short run compared to the long run.

Answer 15

In the short run migration of people who are mostly of working age or students can lead to an increase in aggregate supply, however when they begin to age and have children or become more dependent in their old age, the affect on aggregate supply may stagnate.

Question 16

Explain how completion policy and regulation affects AS in the long run.

Answer 16

If firms are forced to compete with each other, rather than operate as monopolies, they have to cut prices or improve their quality. Effective policing of competition will increase aggregate supply.
If the government makes new laws to make it easier to set up and run businesses, then aggregate supply will increase. This is referred to as a cut in red tape or government bureaucracy, some regulations add to firms costs leading to a decrease in AS.

Question 17

Explain how changes in the minimum wage affect AS in the long run.

Answer 17

Increases in the minimum wage can increase costs for firms, leading to a fall in aggregate supply.

However some evidence suggest that an increase in the minimum wage would lead to increased productivity and therefore an increase in aggregate supply.

Question 18

Explain how changes in the tax and benefit system may affect AS in the long run?

Answer 18

A cut in taxes on firms might increase aggregate supply. A cut in benefits might make people more desperate to keep their jobs or to find work, meaning productivity increases.
However, it might mean, that people are less healthy or are unable to concentrate at work, and could worsen living standards.