Download Aggregate supply

Aggregate supply
• The AS curve shows the level of output on the whole
economy at any given level of average prices.
• SR assumes that the prices of factors of production
such as wage rates are constant. Firms will supply extra
output if the prices they receive increases.
• SRAS = upward sloping.
• Increase in a firms costs of production will shift the
SRAS curve upwards, a fall in costs will shift it
downward.
• LR assumes that prices of the factors of production are
variable but that the productive capacity of the
economy is fixed. The LRAS curve shows productive
capacity of the economy at any given price level.
• LRAS curve shows the productive capacity of the
economy in the same way that a PPF or trend rate of
growth shows productive capacity.
SRAS Curve
• The macroeconomic supply curve = AGGREGATE SUPPLY
CURVE.
• Sum of all industry supply curves in the economy.
• Shows how much firms are willing to supply at a given
price.
• SRAS = upward sloping
• Short run = period when money wage rates, and the prices
of all factors of production in the economy are fixed.
• Should a firm wishes to extend its output in the SR it will
not increase its number of workers. Taking on extra staff is
expensive and sacking staff when they are no longer
required is equally expensive in terms of industrial
relations.
• In the SR a firm will respond to increases in demand by
working its existing workforce harder for instance through
overtime.
• Overtime 1.5 times basic rate of pay.
• Basic pay rates will remain constant,
earnings will rise increasing the
marginal and average costs per unit
of output.
• Where the is imperfect competition
and firms have the power to increase
prices the rise in labour costs will
lead to a rise in prices. Leading to a
rise in the average price level of an
economy.
• In the short term an increase in
output for firms is likely to lead to an
increase in their costs which will in
turn lead to an increase in prices,
although this increase is likely to be
small.
• In the SR the aggregate supply curve
is relatively price elastic.
Price level
Incentives to work
SRAS
P2
P1
0
Q1
Q2
Real output
• An increase in output Q1:Q2
leads to a moderate rise in
average price level P1:P2
• If demand falls in the short
run some firms in the
economy may react by
cutting their prices to try and
stimulate extra orders.
However the opportunity to
cut prices will be limited.
• The AS curve is relatively
price elastic.
Price level
Incentives to work
SRAS
P2
P1
0
Q1
Q2
Real output
• SRAC shows
relationship between
aggregate output and
average price.
• It is drawn on the
assumption that costs
in particular the wage
rate remain constant.
• A change in costs is
shown by a shift in the
curve
Price level
Shifts in the SRAS curve
SRAS2
P2
SRAS1
P1
SRAS3
P3
0
Q1
Real output
• An increase in wage
rates will increase
production costs. Some
firms will respond by
raising prices. At any
given level of output a
rise in wage rates will
lead to a rise in the
average price level.
• This is shown by a shift
in the SRAS curve from
SRAS 1 to SRAS 2.
Price level
Shifts in the SRAS curve – Wage rates
SRAS2
P2
SRAS1
P1
SRAS3
P3
0
Q1
Real output
• A general fall in the prices
of raw materials may
occur. Perhaps world
demand for commodities
falls or the value of the
currency increases making
imports cheaper . A fall in
the cost of raw materials
will lower production
costs and will lead to firms
reducing the prices of
their products.
• There will be a shift in the
SRAS curve downwards
SRAS1:SRAS3.
Price level
Shifts in the SRAS curve – Raw material prices
SRAS2
P2
SRAS1
P1
SRAS3
P3
0
Q1
Real output
• An increase in the tax
burden on industry will
increase costs.
• Hence the SRAS will be
pushed upwards
SRAS1:SRAS2.
• When there is a large
change in wage rates,
raw material costs or
taxation a supply side
shock is said to occur.
This is a significant
impact on AS pushing
the SRAS curve upwards.
Price level
Shifts in the SRAS curve – Taxation
SRAS2
P2
SRAS1
P1
SRAS3
P3
0
Q1
Real output
The long run aggregate supply curve
• In the long run there is a limit to how much
firms can increase their supply.
• They run into capacity constraints.
• There is a limit to the amount of labour that
can be hired, capital equipment is fixed in
supply, labour productivity has been
maximised.
• It can therefore be argued that in the LRAS
curve is fixed at a given level of real output.
Price level
• LRAS curve shows the
productive potential
of an economy.
• It shows how much
real output can be
produced over a
period of time with a
given level of factor
outputs such as labour
and capital equipment
and a given level of
efficiency in
combining those
outputs.
LRAS
0
Real output
– LRAS curve is the level
of output associated
with production of the
PPF of an economy.
– Any point on the
boundary AB is one
which shows the level
of real output shown
by the LRAS curve.
Services
• LRAS can be linked to
three other economic
concepts:
A
PPF
0
B
Goods
– LRAS curve is the level
of output shown by
the trend or long term
average rate of growth
in an economy.
– When output is above
or below this long
term trend level an
output gap is said to
exist.
Output gap
GDP
• LRAS can be linked to
three other economic
concepts:
Trend rate of
growth = position
of LRAS curve.
SR growth
path
0
Time
Output gap
GDP
• There are short term
fluctuations in actual
output above and
below the trend rate.
• This shows that
actual output can be
above or below that
given by the LRAS
curve.
Trend rate of
growth = position
of LRAS curve.
SR growth
path
0
Time
LRAS
• When actual output is above the trend rate and so to the right of the LRAS curve
economic forces will act to bring GDP back towards its trend rate growth.
• When it is below its trend rate of growth and so to the left of the LRAS curve the
same but opposite forces will bring it back to that long run position.
LRAS
•
•
•
•
The LRAS curve shows the level of FULL CAPACITY output of the economy.
At full capacity there are no underutilised resources in the economy.
Production is at its long run maximum.
In the short run an economy might operate beyond full capacity creating a positive
output gap. However this is unsustainable and the output in the economy must fall back
to its full capacity levels.
Shifts in the LRAS Curve
• Likely to shift over time.
• Quantity and quality of economic resources
change over time, as does the way in which
they are combined.
• There changes bring about changes in the
productive potential of an economy.
Causes of shifts in the LRAS curve
• Education & training which raises the skills of the workforce
and levels of productivity.
• Investment in capital equipment which raises the stock of
physical capital and hence pushes out the PPF.
• Technological advances allow new products to be made or
existing products to be produced with fewer resources.
• Increased world specialisation through international trade
allowing production to be located in the cheapest and most
efficient place in the world economy.
• Improved work practices such as just in time production
increasing the productivity of both labour and capital.
• Changes in government policy such as the removal of
unnecessary business regulation which increases the
efficiency of firms.
LRAS 3
LRAS 1
LRAS 2
• An increase in
productivity potential
in the economy
pushes the LRAS
curve to the right
LRAS1:LRAS2
• A fall in productive
potential shifts the
curve to the left
LRAS1:LRAS3.
A shift to the right indicates
economic growth – how would
economic growth be represented
on a PPF? How would it be
represented on a trend line?
Classical & Keynesian LRAS curves
• Vertical LRAS curve is called the classical long run
aggregate supply curve.
• Based on the classical view that markets tend to
correct themselves quickly when they are pushed into
disequilibrium by some shock.
• In the long run product markets like the markets for oil,
cameras or meals out and factor markets such as the
market for labour will be in equilibrium.
• If all markets are in equilibrium there can be no
unemployed resources.
• The economy must be operating at full capacity on its
PPF.
Classical & Keynesian LRAS curves
• Keynesian economics point out that there have been
times when markets have failed to clear for long
periods of time.
• Keynesian economics was developed out of the great
depression of 1930’s when large scale unemployment
lasted for a decade.
• If it had not been for WW2 it is believed that large
scale unemployment would have lasted even longer.
• Keynes argued that there is little point in drawing a
vertical LRAS curve if it takes 20 or 30 years to get back
to the curve when the economy suffers a demand side
or supply side shock.
Price level
The Keynesian LRAS curve
• At an output level of 0B the
LRAS curve is vertical as with
the classical LRAS curve. 0B is
the full capacity level of
output of the economy. It is
when the economy is
operating on its PPF.
LRAS
Full
employment
output
Mass unemployment
0
A
B
Real output
• At on output level below 0A
the economy is in a deep and
prolonged depression. There is
mass unemployment. In
theory this would lead to
falling wages.
Reasons for sticky wages
• National minimum wage – wage floor
• Trade union action to maintain wages
• Regional unemployment due to labour
immobility.
• Demotivating factor of lowering wages leading
to lower productivity.
Price level
The Keynesian LRAS curve
LRAS
Full
employment
output
Mass unemployment
0
A
B
Real output
• So at output levels below
0A markets and particular
the labour can fail to
clear. Firms can hire and
fire extra workers without
affecting the wage rate.
Wages are stuck and
there is a persistent
disequilibrium in the LR.
• There is therefore no
pressure on prices when
output expands.
Price level
The Keynesian LRAS curve
LRAS
Full
employment
output
Mass unemployment
0
A
B
Real output
• At an output between 0A
& 0B labour is becoming
scarce enough for an
increase in demand for
labour to push up wages.
• This then leads to a
higher price level.
• The nearer to output 0B
the full employment level
the greater the effect on
an increase in demand for
labour on wages and
therefore the price level.