The document discusses aggregate supply (AS) and its relationship to inflation and real national income. It explains that the shape of the AS curve depends on factors like production capacity, costs of production, and productivity. A Keynesian view of the AS curve is presented, where it slopes upward, indicating inflation rises as output increases towards full employment. Shifts in aggregate supply can occur due to changes in productivity or input costs. The short-run aggregate supply curve (SRAS) slopes upward, while the long-run aggregate supply curve (LRAS) is vertical according to classical economists.

1. Aggregate Supply (AS)

3. Aggregate Supply Inflation Real National Income The shape of the AS curve is important in determining the outcome in the economy AS Yf This shape reflects a Keynesian view of the AS curve. Yf represents ‘Full Employment Output’ – at this point the economy is working to full capacity and cannot produce any more. Y1 An output level of Y1 would suggest the economy is working below full capacity and there would be widespread unemployment. Economy starts to overheat Between Y1 and Yf, increases in capacity are possible but the nearer the economy gets to Yf, the more problems are experienced with acquiring resources to boost production (production bottlenecks) especially labour skills shortages.

4. Aggregate Supply Inflation Real National Income AS1 AS2 Yf1 Yf2 Increases in capacity can occur as a result of a shift in AS (akin to a shift outwards of the Production Possibility Frontier) (PPF)

5. Aggregate Supply Inflation Real National Income SRAS Short run aggregate supply (SRAS) assumes firms only able to increase output at higher costs (e.g. overtime payments) thereby pushing up price level SRAS 1 SRAS 2 SRAS assumes costs such as overall wage rate remain fixed, changes in such costs cause a shift in the SRAS curve (exogenous shocks – input costs)

6. Aggregate Supply Inflation Real National Income LRAS Classical economists assume the long run aggregate supply curve (LRAS) is vertical (perfectly inelastic). This is because they believe that in the long run, there will be no unemployment of resources because markets will clear, thus whatever the rate of inflation, firms will supply the maximum capacity of the economy. Yf

7. Aggregate Supply For our analysis, we will assume the AS curve looks like this! Inflation Real National Income AS