Short run aggregate supply

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Bonnie Crawford
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1 Short run aggregate supply

2 Syllabus snapshot

3 Today we are going to. 1. Understand what is meant by the term short run aggregate supply. 2. Understand why the SRAS curve is upward sloping. 3. Understand why the SRAS curve shifts.

4 Aggregate Supply The total supply of goods and services that firms in a national economy plan to sell during a specific time period. The total amount of goods and services that the firms are willing to sell at a given price level in the economy. The relationship between the price level and the production of the economy.

5 SRAS/LRAS? Short Run Aggregate Supply Long Run Aggregate Supply

6 Why is the SRAS upward sloping?

7 The Short run AS curve (SRAS) Assumes that prices of factors of production such as wage rates are constant. Firms will supply extra output if the prices they receive increase. SRAS = upward sloping. Increase in a firms costs of production will shift the SRAS curve upwards, a fall in costs will shift it downwards.

8 Showing shifts in SRAS

9 Shifts in the Curve Like AD the SRAS curve can shift. If there is a shift to the left it means costs of production may have risen (Cost Push Inflation) Should there be a shift to the right, costs of production have fallen.

10 Changes in Commodity prices Price of oil increases Increase production costs SRAS1:SRAS2 New Equilibrium point B Price level (PL) has increased P1:P2 Income (Y) decreased Yn:Y2 Unemployment increases Rising prices and falling output = stagflation

11 Changes in Commodity prices Price of oil decreases Reduce costs for business, increase profitability. Consumers see a reduction in cost of transport and heating, leading to higher incomes Helps to reduce inflation. Lower prices, more spending power and lower costs of business can help boost economic growth.

12 Increase in wage rates Price level P2 P1 SRAS1 SRAS2 0 Q1 Real output

13 Decrease in raw material prices Price level P1 P3 SRAS1 SRAS3 0 Q1 Real output

14 Increase tax burden on industry Price level SRAS2 P2 P1 SRAS1 0 Q1 Real output

15 Supply side shock

16 Long run aggregate supply

17 Syllabus snapshot

18 Long Run Aggregate Supply (LRAS) 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 the LRAS curve is fixed at a given level of real output.

19 Price level Services LRAS the productive potential LRAS Can you think of the other curve that shows the productive potential of an economy? PPF 0 Real output In order to increase productive capacity what would have to happen? 0 Goods

20 Classical View LRAS 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. LRAS

21 Keynesian view LRAS Keynesian economists argue 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.

22 Keynesian LRAS Curve The curve is different They believe that in the Long Run unemployment will always exist as wages are sticky downwards This means that should AD fall, workers will resist cuts in pay and the economy will not return to full employment as the classical economists say What has to happen at Q3 for there to be full employment?

23 Price level Keynesian LRAS Curve Keynesians say that at low levels of output there is low levels of employment, the curve will be horizontal This is due to spare capacity in the economy This means output can be increased without a cost rise Once pressure is placed on the capacity and inputs become in short supply such as skilled workers, the curve slopes up Once you reach full employment you cannot raise output anymore so the curve is vertical 0 Mass unemployment A LRAS Real output Full employment output B

24 shifts in the LRAS What do these shifts show?

25 Causes of LRAS shifts Education & training Investment in capital equipment Technological advances Increased world specialisation Improved work practices Changes in government policy

26 Assuming the economy is in an initial equilibrium at X, identify where the new equilibrium will be, if: There is an increase in the number of labour strikes which raises average wages but does not improve productivity.

27 Assuming the economy is in an initial equilibrium at X, identify where the new equilibrium will be, if: There is an oil shock which raises oil prices.

28 Assuming the economy is in an initial equilibrium at X, identify where the new equilibrium will be, if: Labour markets are deregulated to enable greater competition from non-eu workers.

29 Assuming the economy is in an initial equilibrium at X, identify where the new equilibrium will be, if: The exchange rate of Sterling depreciates.

Edexcel Economics (A) A-level Theme 2: The UK Economy - Performance and Policies 2.3 Aggregate Supply

Edexcel Economics (A) A-level Theme 2: The UK Economy - Performance and Policies 2.3 Aggregate Supply Detailed Notes 2.3.1 The characteristics of Aggregate Supply The AS curve: Aggregate supply is the