AS Macro Revision Aggregate Supply


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AS Macro Revision Aggregate Supply

  1. 1. AS Macro Revision Aggregate Supply Spring 2014
  2. 2. We add new resources / links / articles every day to our Economics blogs Follow this link for the AS Macro Blog on Tutor2u
  3. 3. Introduction to Aggregate Supply (AS) • Aggregate supply (AS) is the quantity of goods and services that producers in an economy are willing and able to supply at a given level of prices • Short run aggregate supply (SRAS) is the relationship between real GDP and the price level • SRAS shows how much output the economy can generate in the short-term at each price level • A rise in the price level should stimulate an expansion of supply • When prices are falling, production may contract • The main factor causing a shift in SRAS is the cost of producing goods and services
  4. 4. The Short Run Aggregate Supply Curve (AS) General Price Level A rise in the price level causes an expansion of aggregate supply AS GPL2 The short run AS curve is upward sloping because higher prices for goods and services make output more profitable and enable businesses to expand their production by hiring less productive labour and other resources GPL1 A fall in the price level causes a contraction of aggregate supply GPL3 Y3 Y1 Y2 Real GDP
  5. 5. Shifts in Short Run Aggregate Supply (AS) Input costs • • • • Wage costs per unit of output Labour productivity (higher efficiency lowers unit costs) Raw material and component prices Interest rates, business rents, fuel, energy costs Business taxes, subsidies and imported costs • • • • VAT, environmental charges / employment taxes Scale and size of government subsidies to certain industries Business rates, costs of meeting business regulations Cost of imported components (affected by the exchange rate + fluctuations in world commodity prices) Supply shocks • E.g. A hurricane, a tsunami or the effects of drought, flooding or political crisis which can have an effect on a country’s national output
  6. 6. Showing Shifts in Short Run Aggregate Supply General Price Level A shift from AS1 to AS2 is an inward shift of short run aggregate supply AS2 GPL1 AS1 AS3 A shift from AS1 to AS3 is an outward shift of short run aggregate supply Y2 Y1 Y3 Real GDP
  7. 7. External Factors affecting Aggregate Supply (AS) World oil and gas prices • The UK is a net importer of oil – an input used in many different industries Energy prices / costs • The UK is also a net importer of energy source such as coal Other mineral / metal prices • E.g. Rubber, iron ore, rare earths (used in many electronic products) Foodstuff prices • E.g. International prices for fresh foods, coffee, wheat, cocoa, sugar Import tariffs / quotas • The UK is a member of the European Union which sets a common import tariff on different goods and services coming into the EU Single Market
  8. 8. Explaining the non-linear SRAS curve • When spare capacity is high then SRAS will be elastic • A rise in AD can be met easily by increased output • There is little threat of rising prices (inflation) • The elasticity of SRAS curve falls as output increases • The amount of spare capacity declines • Possibility of diminishing returns in production • Bottlenecks in supply of inputs and components • Resource shortages as the economy approaches full employment e.g. Skilled labour becomes more scarce • When SRAS becomes perfectly inelastic the economy is at full capacity (equivalent to being on the PPF boundary) • Further increases in AD at this point are purely inflationary in the short run with little extra output
  9. 9. The (Keynesian) Non-Linear Aggregate Supply Curve General Price Level AS An outward shift in AD from AD1 to AD2 can be met without an increase in the price level because short run aggregate supply is highly elastic AD5 AD4 GPL1 AD3 AD2 AD1 Y2 Y1 Real GDP
  10. 10. The (Keynesian) Non-Linear Aggregate Supply Curve General Price Level GPL5 AS An outward shift in AD from AD3 to AD4 causes a sharp rise in the general price level because AS is inelastic (i.e. output is close to full-capacity levels) AD5 GPL4 AD4 AD3 AD1 Real GDP AD2 Y3 Y4
  11. 11. Long-Run Aggregate Supply (LRAS) In the long run, the ability of an economy to produce goods and services to meet demand is based on the state of production technology and the availability and quality of factor inputs. General Price Level LAS1 General Price Level Yp is the estimated potential level of real national output in the long run Yp Real GDP LAS1 LAS2 An outward shift of LRAS shows a rise in productive potential Yp1 Yp2 Real GDP
  12. 12. Increasing LRAS – Productive Potential • Changes in potential GDP are brought about by: • Changes in labour supply available for production (i.e. more people join the labour force) • Changes in the stock of capital inputs – affected by the level of gross capital investment • Changes in efficiency of allocation of factor inputs • Improvements in the quality of factor inputs / productivity of inputs • Advances in the state of technology • An outward shift of LRAS signifies an increase in longrun potential output and employment • A higher level of LRAS signifies real economic growth
  13. 13. Key Factors affecting Long-Run Aggregate Supply Higher Productivity of Labour and Capital I.e. a rise in output per person employed or increased efficiency of technology Increased Labour Market Participation Gains from Innovation and Enterprise i.e. A growing Labour Supply and a rise in the number of people in work These are two key factors that determine competitiveness Capital Investment Including capital spending by businesses, inward investment from overseas and Public Sector (Government)
  14. 14. Productivity Productivity measures the efficiency of the production process Factor Inputs (land, labour and capital) Factor Productivity Output (efficiency) • In the long run, productivity is a major determinant of economic growth and of inflation • A fall in labour productivity leads to a rise in firms’ (unit) costs of production (assuming that the level of wages remains the same) • Higher productivity allows businesses to pay higher wages and achieve increased profits at the same time
  15. 15. Get help on the AS macroeconomics course using twitter #econ2 @tutor2u_econ