Aggregate Supply Flashcards
There are two types of AS curve
- Aggregate supply is the total output produced in an economy at a given price level over a given period of time. There are 2 types of AS curve:
Number 1 = short run aggregate supply. This slopes up from the left to the right. They show that with an increase in the price level, there’s an increase in the amount of output firms are willing to supply.
- If SRAS is PRICE INELASTIC, the SRAS curve slopes steeply UPWARDS.
- If SRAS is PRICE ELASTIC, the SRAS curve would be less steeop
Number 2 = In the long run, its assumed that an economy will move towards an equilibrium where all resources are being used to full capacity. This is shown by the long run aggregate supply curve.
- The LRAS curve is vertical. An increase in the price level won’t cause an increase in output because the economy is running at full capacity, so it can’t create any more output.
Changes in the Costs of production cause the SRAS to shift
- SRAS curve will shift if there’s a change in the costs of production.
- A reduction in the costs of production means that at the same price level, more output can be produced, so the SRAS curve will shift to the right.
- E.g. a reduction in the price of oil might shift the curve from SRAS to SRAS1 - so at price level P, output would increase from Y to Y1.
- Changes in things such as wage rates, the taxes firms pay, exchange rates and efficiency levels will cause shifts of the SRAS curve.
- A sudden decrease in aggregate supply (leading to a price increase) could also be caused by supply-side shocks, such as natural disaster or war.
Changes in the Factors of Production cause the LRAS curve to shift
- Long run aggregate supply is determined by the factors of production - LRAS curve will shift if there’s a change in the factors of production which affects the capacity of the economy.
- Improvements in the Factors of Production increases the capacity of the economy, and will shift the LRAS curve to the right, e.g from LRAS to LRAS1. This increases output from Yf to Yf1 - the same price level now corresponds to a higher level of output.
- E.g. investment that leads to advances in technology and more efficient production will increase maximum output
- Other examples of improvements in the factors of production whichmight shift the AS curve to the right:
- Improvement in education and skills - better education and training should => more productive individuals
- Demographic changes - e.g. skilled workers migrating to a country can increase the economy’s capacity
- A supply of new resources - new resources may mean a maximum output of the economy can be increased.
- Improvements in health care => overall health of workers improve -> less time off work -> increase productivity.
- Changes in government regulations
- An increase in competition - cause inefficient firms to close - increasing economy’s capacity
- Promoting entreprise e.g. providing economic incentives or guidance
- Increasing factor mobility e.g. training schemes to reduce occuptional labour immobility
- a deterioation in factors of production that reduces an economy’s capacity will cause the LRAS curve to shift to the left, e.g. if there’s a massive reduction in the supply of oil then the maximum possible output will be reduced.
Banks can play a part in determining the Position of the LRAS curve
- Firms often borrow money from banks to invest, usually so that they can increase their output - e.g. a firm might borrow money to invest in new machinery
- If a country’s has a strong banking system then this will help its economy to grow. It will mean there’s more money available for investment in the economy, and this should lead to an increase in the productive potential (capacity) of the economy.
- So improvements in a country’s banking system will shift the LRAS curve to the right.
A Rise in Demand might cause an ‘Accelerated’ increase in investment
- One way businesses determine whether investment is needed is to look at the current rate of change of national income. So if national income is growing rapidly, then businesses will invest heavily.
- This is called the accelerator process (or the accelerator effect). Firms will make ‘accelerated’ investment in capital goods, expecting to increase output and make profit in the future.
- This is likely to occur when the economy is going through a recovery, or at the start of a boom. These are times when demand will be rapidly increasing and firms will need to invest to meet the demand.
- The multiplier and the accelerator work together. E.g:
- During a recovery, AD will be growing
- This => firms increasing levels of investment => another increase in AD
- This increase in AD is then ‘multiplied’, making growth in national income more rapid…
- …. which leads to even more ‘accelerated’ investment - The accelerator process and multiplier effect can both also happen in reverse - for example, during a recession, there’s likely to be a fall in demand and a fall in investment, which will then have a reverse multiplier effect.
- This can lead to a constant cycle of output first rising and then falling.
The Keynesian LRAS curve is L-shaped
Not everyone agrees that the LRAS curve is vertical.
Keynesian economists argues that the LRAS curve actually looks like (digram on pg 147)
- At low levels of output, aggregate supply is completely elastic - this means there’s spare capacity in the economy, so output can increase without a rise in the price level. For example, if there’s a lot of unemployment in an economy, firms will be able to employ more workers and increase output, without increasing price levels.
- When the curve begins to slope upwards this shows that the economy is experiencing problems with supply (known as bottlenecks), which are causing increases in costs. For example, this might be due to a shortage of labour, or a shortage of certain raw materials.
- The curve becomes vertical when the economy is at full capacity (yf) - here, aggregate supply is completely inelastic. All resources are being used to their maximum potential and output can’t increase any more.
