Theme 2 - Aggregate Supply Flashcards
What is aggregate supply?
The total value of output of goods and services that producers in an economy are willing and able to provide at a given price level in a given time period
What influences the shape of the AS curve?
The level of capacity that exists within an economy - it is the sum of all industry supply curves in an economy
Why does the SRAS curve slope upwards?
- In the short run, if a business wants to increase production, they need to increase the hours of work their employees do. They won’t necessarily want to employ additional full-time permanent staff as they would then be committed to them, and have to potentially sack them if sales fell later which would create a bad reputation and may be expensive
- Firms may decide to take on temporary workers or get present workers to work overtime or work harder, which would entail some form of incentive, such as bonuses or overtime pay
- Even though basic wage rates have stayed the same, both the average and marginal cost of labour per good produced will rise - the business is paying more in wages for every good they produce. This would be passed onto the consumer in the terms of increased prices and there only needs to be rising prices in some sectors for the price level of the economy to rise
- The curve is upward sloping as firms are willing to supply more but only at a higher price
Why is SRAS likely to be elastic?
An increase in output by firms is likely to lead to an increase in costs which leads to a rise in prices as they pass these costs onto consumers. However, because factor prices are constant, the increase in prices will be relatively small. If demand falls firms will react by cutting prices in an attempt to stimulate sales. However, they will not be able to achieve much of a reduction because of constant prices and an unwillingness in the short run to lay off workers
What causes movements and shifts of SRAS?
A change in price level will lead to movement along the curve, but a shift is caused by a range of other factors
Relationship between SRAS and LRAS
Short run is the period of time where at least one factor or production is fixed and cannot be changed. On the SRAS curve, money wage rates, factor prices and the state of technology are fixed and can’t change; a change in these results in a shift in the curve
In the long run, all factors of production are variable
What factors influence SRAS?
- Changes in costs of raw materials and energy
- Changes in exchange rate
- Changes in tax rates
Supply side shocks occur when there are significant changes in any of these factors
How do changes in the costs of raw materials and energy influence SRAS?
In increase in the costs increases the cost of production. This means the SRAS curve will shift left as it will cost more to make the same amount of goods and therefore businesses will only produce this amount of goods if prices rise.
How do changes in exchange rates influence SRAS?
A weaker pound will lead to an increase in the price of imports and this will cause SRAS to decrease as production becomes more expensive. If the pound becomes stronger, imports will be cheaper and so SRAS will increase - particularly important in UK as we are heavily dependent on imports
How do changes in tax rates influence SRAS?
Taxes increase the cost of production and thus they cause a fall in SRAS, shifting it to the left. Subsidies shift the curve right as they decrease costs
What is SRAS?
The relationship between planned national output (GDP) and the general price level. We assume that productivity and costs of production and the state of technology is constant in the short run when drawing SRAS. It is assumed that wage rates and prices and other factor inputs are fixed in the short run
LRAS curve
In the short run, supply can be increased by offering overtime, but in the long run, there will be a limit on how much supply can be increased. There is a limit on the number of people and machines available and once labour productivity is maximised, supply cannot be increased any further. On the LRAS curve, wage rates are variable and can change
Classical LRAS curve
- classical economists argue that in the long run, the AS curve is fixed at a given real output level
- the LRAS determines maximum potential output when all FoPs are being used at a sustainable rate
- firms run into capacity constraints - there is a limit in an economy on the amount of land, labour and capital.
Keynesian LRAS curve
Keynesian economists point out that there have been times when markets have failed to clear for a long time e.g. the Great Depression. As a result, Keynesian economists believe there are 3 points to the LRAS curve:
Section A - horizontal:
- Lots of spare capacity (of workers, capital and land), many scarce resources and FoPs available.
- Machines aren’t working as hard, so there is lots of spare capacity
- Supply is perfectly price elastic
- Firms are willing an able to respond to an increase in AD without there being a rise in price level, because of the spare capacity
Section B - increasing:
- Spare capacity is decreasing, the quantity of available raw materials decreases
- Increased demand for extra workers, the efficiency of new workers will increase and wages will rise.
- Costs of production for firms rises
- AS curve becomes more inelastic and the price level of goods and services rises
Section C - vertical:
- There is no more spare capacity in the economy, so there are no additional workers/resources available
- AS becomes perfectly price inelastic
- Any increase in AD will be purely inflationary - real GDP remains the same, only prices rise - supply can’t meet demand
How is an increase in LRAS shown on a PPF?
Shift the frontier outwards
What factors influence (shift) LRAS?
Technological advancements
Changes in relative productivity
Changes in education and skills
Changes in government regulations
Demographic changes and migration
Competition policy
How do technological advancements influence LRAS?
Improvements in tech shift the LRAS curve to the right, meaning more can be produced.
This is because it will speed up production, so more goods can be produced with the same amount of resources
How do changes in relative productivity influence LRAS?
The more productive the economy is, the more that will be produced with the given resources.
Productivity depends on a range of factors, such as efficiency, skill of labour, and technology
If the UK is more productive than other countries, it will encourage production of that good in the UK, so investment will be increased, and this will increase LRAS
How do changes in education and skills influence LRAS?
A more skilled workforce will be more employable and work quicker and more efficiently within their jobs, so the output per worker will increase, which will shift the LRAS to the right. Education could also be used to improve the occupational mobility of labour which decreases structural unemployment as people are able to switch to new jobs. This will ensure all resources are used efficiently
How do changes in government regulations influence LRAS?
- They can increase the size of the workforce; reduce benefits, subsidise childcare, change working age etc; will increase LRAS because there are more resources in the economy, so more can be produced
- Policy can increase research and development by offering tax breaks for business which invest in research. If a business can come up with a good idea, then it will increase the LRAS as it will increase productivity
- They could make it easier to set up businesses and increase incentives to be entrepreneurial (i.e. lower corporation tax) which would increase companies, jobs and output so increase LRAS.
- In general, high regulation on businesses will limit LRAS as it will increase costs and the time taken to undertake tasks, which will reduce output.
How do changes in demographics and migration influence LRAS?
- If immigration is higher than emigration, the population will grow and so therefore there will be more workers which will increase the LRAS.
- The value and importance of this immigration will depend on the age of the immigrants and their skills.
- In an ageing population or a young population, LRAS will be lower as the working population is smaller so therefore less goods can be produced. The more people who are of working age, the higher the LRAS.
How does competition policy influence LRAS?
- The government can promote competition between businesses and markets which will force them to improve the quality of their goods or lower prices.
- In order for businesses to do this and still make a profit, they have to improve their efficiency and this efficiency will mean that more goods and services can be produced, so LRAS will increase.
- However, less competition can sometimes be beneficial if it encourages investment and innovation.
Why does a Keynesian diagram not need a separate SRAS curve?
They believe AS is the same in the short and long run
