Y12 Booklet 2: Aggregate Supply & Macroeconomic Equilibrium Flashcards
What is most Classical Economics characterised by?
- belief in free markets
- no government intervention
- consumer sovereignty
What is Say’s Law? What does this mean?
“supply creates its own demand”
aggregate supply creates aggregate demand
1) more output is produced (increase AS)
2) workers are paid more
3) households earn more income
4) consumers can demand more products (increase AD)
Who is Say? What is the conclusion to his law?
Jean-Baptiste Say
in general, over-supply is impossible, because for supply to be produced workers must be paid, and so they will demand this excess supply
What is a problem with Say’s Law?
assumes APC = 1, thus no savings
What is “laissez-faire” policy?
an economic policy with minimal government intervention
What is an example of a failed Classical “laissez-faire” policy? Who therefore rejected Say’s Law?
1) unemployment (excess supply of labour) in economy
2) over-supply, so wages fall (extension of demand)
3) incomes fall, so less goods can be demanded
4) derived demand for labour falls, more unemployment
John Maynard Keynes
What is the short-run?
a time period for which at least 1 factor of production (usually capital) is fixed in quantity
What is the long-run?
a time period for which all factors of production are variable in quantity
What is SRAS?
short-run aggregate supply
What is LRAS?
long-run aggregate supply
What is the SRAS curve?
What is the LRAS curve?
Why is the SRAS relatively flat?
increase in costs of prod disproportionately small, compared to increase in output
SRAS = price elastic
Why is the LRAS perfectly vertical?
at max. productivity, any change in price will have no effect on supply, since no more can be produced
What causes SRAS curve to shift?
change in profitability (costs of production/incentive to supply)
What does the SRAS reflect?
current productive capacity
What causes LRAS curve to shift?
change in factors of production (e.g. investment in capital, increased labour productivity)
What does the LRAS reflect?
maximum productive capacity with current factor endowment
What can the LRAS curve criticise?
too much focus on AD
as AD increases, output stays the same (inelastic), but price does, causing inflation
What does the Keynesian model look like?
What happens in the flat part of the Keynesian model?
- mass unemployment
- low wages
- supply = perfectly price elastic
- low cost to increase output, so low prices
What happens in the steep part of the Keynesian model?
- low unemployment
- high, competitive wages
- supply = perfectly price inelastic
- high cost to increase output, so high prices (inflation)
Which part of Keynesian model do Classic economists agree/disagree with?
agree - short-run aggregate supply
disagree - long-run aggregate supply
Why do Classicals and Keynes disagree?
Classics believe that when AD shifts left, SRAS will shift right and wages will fall to return to full employment of factors of production, therefore government intervention is unnecessary and opt for “laissez-faire” policy
but Keynes believes wages are “sticky downward” and won’t fall, thus requiring government intervention to return to full employment of factors of production
When is a shift right of AD beneficial on the Keynesian model?
on the flat part
where spare productive capacity is high, since employing more factors of prod. won’t cause scarcity, so is cheap and not inflationary
When is a shift left of AD beneficial on the Keynesian model?
on the steep part
where spare productive capacity is low, since employing less factors of prod. will cause less scarcity, so is cheaper and deflationary
When is a shift right of AD harmful on the Keynesian model?
on the steep part
where spare productive capacity is low, since employing more factors of prod. will cause scarcity, so is expensive and inflationary
When is a shift left of AD harmful on the Keynesian model?
on the flat part
where spare productive capacity is high, since employing less factors of prod. will decrease output significantly
What is the diagram for macroeconomic equilibrium?
(according to Classical economists)
