AS - SRAS + LRAS Flashcards
CLASSICAL
Can have SRAS (upward sloping) + LRAS (vertical)
CLASSICAL SRAS POSITION DETERMINED BY
Costs of production in economy
If increase in COP, SRAS shifts to LEFT
If decrease in COP, SRAS shifts to RIGHT
COP that can affect all firms in economy
Wages (If wages throughout economy increase, will increase COP for firms so SRAS will shift to left)
Raw material/commodity prices (if increase then COP increases, SRAS shifts to left)
Oil price ((major COP - important input for all firms in UK economy whether its transportation of goods /access goods / input in production) when oil price increases, COP for firms increase, SRAS shifts to left))
Business Taxes (VAT) (if VAT increases, COP increase, SRAS to left)
Import Prices (SPICED/WIDEC) (important for firms in UK economy that rely on imports of raw materials in order to produce + import prices can change when exchange rate changes - strong exchange rate = imports cheaper so firms who import raw materials will see decrease in COP where SRAS shifts right)
SPICED/WPIDEC
Strong exchange rate-strong pound imports cheaper exports dearer
Weak exchange rate - weak pound imports dearer exports cheaper
When SRAS shifts there is supply-side shock in economy
As shifts can happen quickly
COP can happen overnight so they are shocks
Shocks can be positive if COP decrease SRAS shifts to right
Shocks can be negative when SRAS shifts to left + when put AD on diagram (higher inflation too)
Negative supply-side shocks can lead to stagflation
CLASSICAL LRAS
Vertical LRAS to represent 1 level of output economy will always produce at in LR (Yfe)
Yfe is full employment level of output + represents max level of output that economy can produce using all FOP at sustainable levels (possible to deviate from that - to increase output beyond Yfe if using FOP unsustainably
- using labour overtime - eventually labour will burn out - unsustainable production
- if using capital overtime (machinery used 24/7 - machinery will break down - unsustainable production)
When economy is at natural rate of unemployment (classical LRAS)
Thats when we are at full employment level of output (fully employing all FOP)
In UK natural rate of unemployment is 4.5%
WHY LRAS SHIFTS TO RIGHT (CLASSICAL)
Q2CELL
Quality + Quantity of FOP: Capital, Enterprise, Land, Labour
If quantity/quality of FOP increasing + improving, LRAS shifts to right
Also there may be improvement in Productive Efficiency of economy (but no change in FOP)
1. Increase in quantity of FOP
2. Increase in quality of FOP
3. Improvement in productive efficiency
If Improvement in productive efficiency, LRAS will shift to right + potentially economy can produce more. What factors can cause this?
- Increase in labour productivity
- Increase in investment in economy (firms spend money on capital goods e.g tech advances, R&D spending)
- Infrastructure improvements (transport e.g building new roads/airports will reduce LR costs for all firms in economy as means transporting goods+services becomes quicker,cheaper,more efficient so LR COP decrease, improving productive efficiency of economy, LRAS shifts to right)
- Increases in quantity of labour (immigration - working age migrants entering country increase labour force size, cutting income tax where inactive become active)
- Competition (privatisation/deregulation/competition policy, if competition improves throughout economy then firms will be trying to reduce cost as much as possible to stay competitive + beat rivals - increases productive efficiency)
- New resource discoveries (find new resources, quantity of land increases so LRAS shifts to right)
What about if LRAS shifts to left in economy
Happens if there is:
- big decrease in labour productivity
- mass capital depreciation
- war/conflict/natural disaster -> destroys infrastructure -> reduces quantity of capital, could lead to death -> reduces quantity of labour
- pandemic/health crisis - decreases productivity of labour + quantity of labour if death caused
- hysteresis (caused by long-term unemployment where workers become discouraged + drop out of labour force) reduces quantity of labour
- emigration from economy (workers of working age leave economy) reduces quantity of labour
KEYNESIAN LRAS - what do they agree with
Keynesians agree with reasons why LRAS can shift to right/left
(shift to right increases potential output, shift left decreases potential output)
KEYNESIAN LRAS - what do they disagree with
Disagreement occurs over shape of LRAS + what LRAS represents
- keynesians dispute idea of there being SRAS + LRAS
- but believe there is point where reach full employment where curve becomes vertical but think that economy can be producing less than Yfe + could be LR level of output (isnt just 1 LR level of output economy will always be at - if economy producing below Yfe that could be LR equilibrium in economy)
- dispute shape
They say that shape is bendy looking due to level of SPARE CAPACITY in economy (e.g if economy in deep recession where output below Yfe, they say its possible to increase production without there being increase in inflationary pressure as there is mass unemployment of FOP - so easy for firms to use up excess FOP without having to pay more for them- so wages/capital/price wont rise so inflation rate will remain constant at times of deep recession when increase production on horizontal part of LRAS)
- but closer we get to yfe, more we are using up spare capacity, more pressure being put on our existing FOP so labour becoming scarcer so to employ labour - wages have to rise, capital becoming scarcer so to employ capital firms have to pay more for it which will increase COP, will pass it on via higher prices in economy so inflation rate will increase eventually to point where we are fully utilising all FOP + not possible to increase output sustainably anymore (there will only be increase in inflation - when supply curve becomes vertical)
- keynesians believe we are not always at Yfe (could be below + that could be LR equilibrium in economy)
