Macro Diagrams Flashcards
The 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.
For example, a reduction in the price of oil might shift the curve from
SRAS to SRAS, - so at price level P, output would increase from Y to Y,.
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.
Long run aggregate supply is determined by the factors of production
the LAS curve will shift if there’s a change in the factors of
production which affects the capacity of the economy.
2)
An improvement in the factors of production increases the capacity of the
economy, and will shift the LAS curve to the right, e.g. from LAS to LRAS,.
This increases output (in other words, there’s economic growth) from Yf to
Yf.
the same price level now corresponds to a higher level of output.
3) E.g. investment that leads to advances in technology and more efficient production will increase maximum output.
4)
Other examples of improvements in the factors of production which might shift the AS curve to the right are:
At low levels of output, aggregate supply is completely elastic
(where the curve is horizontal) .
- 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
C
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 supply 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.
The effect of a shift in AD on the equilibrium point depends on
the slope of the AS curve. This means the effects of an increase
in AD can be quite different in the short and long run.
This graph shows an SRAS curve along with an AD curve.
When there’s an increase in aggregate demand and the
AD curve shifts from AD to AD,, the new equilibrium
point will be at price level P, and output Y,.
There’s been an increase in output, which will lead to an increase in
derived demand, so more jobs are created and unemployment is reduced.
But there’s also been a rise in prices -
this is ‘demand-pull’ inflation.
A decrease in AD will have the opposite effect -
- output will be reduced
and there will be an increase in unemployment, but price levels will fall.
This graph shows an LAS curve along with an AD curve.
Now when the AD curve shifts from AD to AD., the new
equilibrium point will be at price level P., but the output
hasn’t changed (and unemployment can’t fall) - because
the economy is already running at full capacity.
So the only effect is that prices rise
- again,
this is an example of ‘demand-pull’ inflation.
For example, an increase in AS, shown by a shift to the right from SRAS to
SRAS,, will lead to an increase in the capacity of the economy. This will
result in an increase in output - so there’s increased economic growth.
There will be more jobs, reducing unemployment. The price level will tend
to fall and the economy will become more competitive internationally,
improving the balance of payments.
On the other hand, a decrease in AS would worsen the state of all four macroeconomic indicators.
If LRAS increases, then you get similar results.
For example, if long run aggregate supply shifts from LRAS to LRAS, then in
the long run output is increased, the price level falls, the balance of payments
will potentially improve and the economy remains at full employment.
So a shift of the LRAS curve will also tend to cause all four macroeconomic
policy indicators to improve or worsen at the same time.
- Short run and long run economic
growth can be shown with a PPF. - Short run growth is shown by a
movement from, say, point A to point
B, while the PPF itself remains fixed. - Long run growth occurs if there’s an increase
in the capacity of the economy -
this
would make the PPF shift outwards to PPF,.
With a Keynesian LAS curve, the effects of an increase in AD can be slightly different.
If AD increases from AD, to AD.
. the effects are the same as those described
on p.148
- there’s an increase in prices but no increase in output.
This corresponds to an economy that’s already operating at full capacity.
If AD increases from AD, to AD, then there’s an increase in output but
no increase in prices. This corresponds to an economy deep in depression.
If AD increases from AD, to AD,, then there are increases in both output and
prices. This corresponds to an economy operating just under full capacity.
With a Keynesian LAS curve, the effects of an increase in AS can also be slightly different.
If AS increases from LAS to LRAS
, there is a change in the
macroeconomic equilibrium if AD is at either AD, or ADy
However, if AD is at AD,, then there is no change in the equilibrium.
This is why Keynesian economists say that there is little point in aiming to
increase AS during a depression
the macroeconomic equilibrium will
not be affected and there will be no increase in output or employment.
With a Keynesian LAS curve, the effects of an increase in AS can also be slightly different.
If AS increases from LAS to LRAS
, there is a change in the
macroeconomic equilibrium if AD is at either AD, or ADy
However, if AD is at AD,, then there is no change in the equilibrium.
This is why Keynesian economists say that there is little point in aiming to
increase AS during a depression
the macroeconomic equilibrium will
not be affected and there will be no increase in output or employment.
A negative output gap (also called a recessionary gap) is the difference between the level of actual output and trend output
when actual output is below trend output.
A negative output gap will occur during a recession when the
economy is under-performing, as some resources will be unused
or underused (including labour, so unemployment may be high).
A negative output gap also usually means
downwards pressure on inflation.
A positive output gap (also called an inflationary gap) is the
difference between the level of actual output and trend output
when actual output is above trend output.
A positive output gap will occur during a boom when the
economy is overheating, as resources are being fully used or overused (so unemployment may be low).
A positive output gap also usually means upwards pressure on inflation
During a recovery an economy will go from having a negative output gap
to having a positive output gap as actual output rises above trend output.
During a recovery an economy will go from having a negative output gap
to having a positive output gap as actual output rises above trend output.
An output gap can be shown on a PPF. For example, in this diagram:
Point W shows the economy operating at full capacity
all available resources are being used.
Point X is inside the PPF. This shows that some resources are not
being used fully
there’s a negative output gap.
Point Z is outside the PPF, meaning the economy is producing a level
of output that is ‘beyond its potential’.
- this may happen if workers
are working excessively long hours or machines are being overused.
In this case there’s a positive output gap.
An output gap can also be shown using AS and AD curves.
For example, in this diagram:
Point W shows the economy operating at its full productive potential,
using all available resources (i.e. it’s on the LAS curve).
Point X shows the equilibrium of SRAS, and AD, to the left of the LAS
curve. In other words the economy has the potential to supply at a
greater level. The distance between Y, and Y, is a negative output gap.
Point Z shows the equilibrium of SRAS, and AD, to the right of the
LAS curve. The distance between Y, and Y, is a positive output gap.
The short run Phillips curve shows an apparent trade-off between
inflation and unemployment. By plotting historical inflation and
unemployment data, the economist A.W. Phillips found that as
inflation falls, unemployment seems to rise, and vice versa.
So it looks like if the government wants to reduce unemployment,
then it can increase aggregate demand to achieve this..
as long as it’s prepared to accept higher inflation.
However, not everyone agrees that it’s quite this simple.
One problem is that once inflation has gone up, people seem to expect
it to remain high, and they change their behaviour accordingly.
