Topic 1.3 - Aggregate Supply Flashcards
What is aggregate supply?
Total amount the producers in an economy are willing to and able to produce at a given price level in a given time period
Total quantity depends on quantities of input of factors of production employed
amount supplies depends on flexibility of factors of production so we need to consider aggregate supply in the short run (weeks) and the long run (months/years)
Short run aggregate supply (SRAS)
When the prices of factors of production or assumed not to be changing
Firms have little flexibility to vary their inputs
They usually make existing workers work more to increase output
They will pay overtime and increase their prices
In short run, SRAS curve is upwards sloping (elastic)
SRAS curve
Firms wouldn’t want to operate in this way (overtime) indefinitely
They would have to adjust working practices and hire more, therefore becomes long run
What factors encourage firms to supply more in short run?
Change in costs of factor inputs
Change in availability of factor inputs
Change in effectiveness of factor inputs
How would a change in costs effect SRAS?
- Decrease in costs eg-raw materials, would reduce firms costs of production (SRAS2)
- Increase in eg-wage rates, increases firms costs of production (SRAS3)
How would changes in domestic production environment effect SRAS?
Costs faced by firms (taxation rates) affects profitability of firms
Eg - tax burden, enforced regulation (spending more on health and safety), improved transport systems.
How would changes in exchange rates effect SRAS?
If the exchange rate falls the price of imports would increase which would then increase cost for firms ( firms buy a lot of raw materials from abroad)
(Any change in aggregate demand would cause a contraction or expansion of SRAS)
Long run aggregate supply (LRAS)
When factors of production of variable, for example prices of input not fixed
Represents a total possible level of real output, it is influenced by level of capacity and economy
Neoclassical view on long run aggregate supply
Gov should leave market alone to find its way to equilibrium, it would always find its way back
(Invisible hand, forces of supply and demand)
Neoclassical diagram and explanation
The economy has returned to YFE - LRAS curve mustbevertical in long run
Explain using a diagram
Keynesian view of long run aggregate supply
Macro economy not sufficiently flexible enough to enable continuous full employment
Eg1 - in period of recession, firms may have to cut wages to stay in business
Workers may refuse to accept lower wages - employees tend to have slow response to changes in performance of a company/economy
Some workers may be redundant/businesses closing down
Results in falling incomes, deficient AD in long run, meaning long run equilibrium will be below YFE
Eg2 - if firms have pessimistic expectations about AD, reduce their supply of outputs, lower incomes, workers laid off, AD deficient, self-fulfilling pessimism
Keynesian LRAS curve
What causes the LRAS curve to shift?
Quality or quantity of economic resources (FOP) changing overtime
Changes in quantity of labour (immigration laws, age of population, disease/illness), capital goods (how many factories, balance between consumption and investment)
Changes in quality of labour (training, education, gov encouragement/provision of training, capital goods (more advanced research (efficient), advanced tech)
Neoclassical curve shift
Keynesian curve shift
Aggregate supply and production possibility curve comparison
