Aggregate Supply Macroeconomics pack 3 Flashcards
Definition of aggregate supply
Total of all goods and services produced in an econoy each year
Defintion of short-run aggregate supply (SRAS)
The total planned output when the price level can change but the prices and productivity of factor inputs are held constant
Defintion of long run aggregate supply (LRAS)
The total planned output when both prices and average wage rates can change. It is a measure of the country’s productive potential
What is the ‘short run’ in an economic context
The period that begins immediately after an increase in the price level and that ends when input prices have increased in the same proportion to the increase in price levels
Why does the SRAS slope upwards
If real output is to increase in the short run firms will have to pay overtime or more money for quick delivery of raw materials.
As real output rises, costs per unit to the firms are likely to rise.
These increased costs will tend to be passed on to the consumer through higher prices, so the increase in real output gad resulted in a rise un the average price levels
What causes a movement along the SRAS curve
A change in the price levels
What causes a shift in the SRAS curve
Caused by a change in firms costs of production as these change rapidly in the short-run, whereas longer term changes like technology improvements impact on LRAS
Examples of what causes a decrease in SRAS
A rise in:
- Commodity prices (oil, gas, steel, wheat)
- Energy costs (gas prices increase significantly with war in Ukraine and middle east)
- Wage costs
- Indirect taxation
- Government regulation
- Imported raw materials
How does a fall in the exchange rate effect SRAS
Means value of the pound falls
Costs of UK imports are more expensive
Commodity prices and energy prices rise
SRAS shifts inwards
How does the classical long-run aggregate supply graph look
Vertical line at YFE
Classical economists approach to the long run
- Believe that in the long run all markets will clear, meaning there can be no gap between actual and potential output in the long run, and instead the economy will always return to producing at its maximum potential level of output
- Therefore a change in the overall price level does not affect aggregate output, because the economy always rapidly adjusts back to full employment
Example of how the economy goes back to full employment - classical economists
In an economy operating below full employment workers will be willing to take lower wages, due to lower price levels and the existence of unemployed workers who could replace them. This wage flexibility is the key argument of the Classical school and means that in the long run the labour market will clear and the economy will return to full employment.
How does the LRAS curve according to Keynesian long-run
The curve slopes upwards
What do Keynesian economists believe
They believe that is is possible to have a long-run equilibrium where markets do not clear and so there can be spare capacity in an economy in the long-run
Keynesian economists disagree that wages will fall in order to clear labour markets when output is below full employment. They believe that wages are sticky downwards, in contrast to the wage flexibility of the Classical school
What does the shape of the Keynesian LRAS curve show
That there is lots of spare capacity in the economy, it is possible to increase the level of real output with no resulting increase in the average price level. This is because costs will not rise substantially when there is spare capacity in the economy; workers will not bargain up their wages in an economy of high levels of unemployment and there will be surpluses of raw materials
How will a change in price levels affect the classical school LRAS curve
A movement along the LRAS curve will have no impact on real output
List the factors that cause LRAS to shift
- Changes in relative productivity
- Discovery of raw materials
- Net investment
- Demographic changes and migration
- Changes in Government policy
- Education and skills
- Technology advances
- Competition policy
How do changes in relative productivity affect LRAS
Higher productivity (due to better technology and workforce skills) represent an increase in efficiency of factors of production. This will boost the productive potential of the economy and LRAS, there will be a higher output of goods and services for a given number of inputs
How does discovery of raw materials affect LRAS
Will increase the quantity of ‘land’. For example, the discovery of the North Sea Oil
How does net investment affect LRAS
When business investment exceeds depreciation then net investment will be positive. Lead to an increase in the productive potential and LRAS. Out of date capitals are being replaced and there is an additional increase in capital goods allowing increased production
How does demographic changes and migration affect LRAS
An increase in the size of the working population will increase the quantity of labour. This will boost productive potential and LRAS as there are more workers able to produce goods and services
How do changes in government policy affect LRAS
The government may try to boost the quantity of labour in the workforce in order to boost productive potential of the economy and LRAS. Eg. Increasing incentive to work by lowering unemployment benefits and lowering the level of income tax (to increase reward for working)
How does education education and skills affect LRAS
If the education and skill of UK workforce increases there will be an increase in the quality of labour. Boost the productive potential and LRAS as labour productivity will have risen, meaning higher production for a given number of workers in the UK.
How do technological advances affect LRAS
Better technology (production machinery) this will boost the quality of capital. This will boost the productive potential of the economy and LRAS as more can be produced with these more productive and efficient capital goods.
