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Aggregate Supply
What is aggregate supply?
• AS is the total output that all producers in an
economy are willing and able to supply at
each price level
• It is important to distinguish between short
run (SRAS) and long run (LRAS)
• SRAS is when money wage rates are FIXED
• LRAS is the output supplied assuming money
wage rates are variable (but there are two
approaches to LRAS)
Price Level
SRAS
P1
P
Y
Y1
Real GDP
Causes of shifts in SRAS
• Wage rates
• Raw material prices
• Taxation
Shift left (cost increase)
Price Level
SRAS1
SRAS
Real GDP
Shifts of SRAS
• Sudden, unexpected events such as a sudden
rise in the price of oil or a hurricane are
sometimes referred to as supply shocks,
especially if these are large changes
Long run aggregate supply (LRAS)
There are 2 main views on the shape of the LRAS curve
• Keynesians believes that market failure is a common
occurrence, is a serious problem and needs
government intervention to improve the workings of
the market.
• New classical economists believe that markets usually
work efficiently. They think that government
intervention can make a situation worse so should be
kept to a minimum. The government should ensure
that laws, regulations and institutions operate in such a
way as to enable market forces to provide economic
agents with sufficient information and incentives.
Keynesian LRAS
• Keynesians believe that the LRAS supply curve is perfectly
elastic at low levels of output, elastic as output rises, inelastic
as output approaches full capacity and then perfectly inelastic
as full employment of resources is reached.
• When output is low, forms can purchase more factors of
production without raising their prices, so more can be
produced without increasing average cost.
• As output rises, firms start to compete for resources, their
prices rise and the cost of production increases.
• As shortage of resources increase, the LRAS curve becomes
increasingly inelastic until the economy is producing its
maximum output with all existing resources employed and
given technological knowledge.
Keynesian LRAS
Price Level
LRAS
Real GDP
New classical LRAS curve
• New classical economists believe that the
economy will operate at full capacity in the
long run, so they think the LRAS curve is a
vertical line.
New classical LRAS curve
Price Level
LRAS
Real GDP
Shifts in Keynesian LRAS
Price Level
LRAS
LRAS1
A shift can occur if
there are changes in
the quantity or quality
of resources e.g.
changes in the size of
the labour force,
investment, training,
education, healthcare
and technology
Real GDP
Shifts in New classical LRAS curve
Price Level
LRAS
LRAS1
A shift can occur if
there are changes in
the quantity or quality
of resources e.g.
changes in the size of
the labour force,
investment, training,
education, healthcare
and technology
Real GDP
Activity 1
•
a)
b)
In 2001, while the world’s 500 biggest companies increased
their capital expenditure by 17%, the UK’s top 500
companies increased their spending by only 12%
What effect will an increase in investment have on a
country’s
i) aggregate demand
ii) potential output
Identify two reasons why the world’s 500 biggest companies
might have invested more on percentage terms that the
UK’s top 500 biggest companies
Activity 2
• Explain what effect the following are likely to
have on the SRAS curve;
a) An increase in the price of oil
b) A rise in wages matched by an increase in
productivity
c) A fall in corporation tax
Activity 3
• In 2001, output in Greece rose by 3.8%,
inflation was 3.7% and unemployment was
11.2%. Using this information, draw and
decide at which point on a Keynesian LRAS
curve Figure 5 appeared to be producing at in
2001