AGGREGATE SUPPLY

• Aggregate supply

  The volume of goods and services produced within the economy at a given price level
• Aggregate supply

  • Indicates the ability of an economy to produce goods and services
  • Shows the relationship between the real GDP and the average price levels
• Short-run AS curve

  In the short run, if a business wants to increase production they need to increase the hours of work their employees do
• Firms may decide to take on temporary workers or get present workers to work overtime or work harder, which would entail offering some form of incentive such as bonuses or one and a half times the basic rate of pay for overtime
• Even though basic wage rates have stayed the same, both the average and marginal cost of labour per good produced will rise - the business is paying more in wages for every good they produce
• This would be passed on to the consumer in terms of increased prices and there only needs to be rising prices in some sectors for the price level of the economy to rise
• Short run AS

  Upward sloping as firms are willing to supply more but only at a higher price
• Short run AS

  • Likely to be elastic (i.e. output is relatively responsive to a change in price- it changes by a bigger percentage than price)
  • An increase in output by firms is likely to lead to an increase in costs which leads to a rise in prices as they pass these costs onto consumers
  • Because the factor prices are constant, the increase in prices will be relatively small
  • If demand falls firms will react by cutting prices in an attempt to stimulate sales, but they will not be able to achieve much of a reduction because of constant prices and an unwillingness in the short run to lay off workers
• Short run

  The period of time when at least one factor of production is fixed and cannot be changed
• Long run

  The period of time when all factors of production are variable
• There is disagreement amongst economists on the shape of the LRAS
• Factors influencing short run AS

  • Changes in costs of raw materials and energy
  • Changes in exchange rates
  • Changes in tax rates
• Supply side shocks


  Significant changes in any of the factors influencing short run AS
• Long run AS curve


  • In the long run, supply can be increased by offering overtime but there will be a limit on how much supply can be increased
  • There is a limit on the number of people and machines that are available and once labour productivity is maximised, supply cannot be increased any further
  • On the LRAS curve, unlike the SRAS curve, wage rates are variable and can change
• Classical view of LRAS

  • In the long run, AS is independent of the price level and is determined by the level of all factors of production and the quality of technology
  • The LRAS is a measure of a country's potential output and the concept is linked to the idea of PPF; it shows the productive potential of the economy
  • It shows the full capacity output i.e. where all resources are being fully utilised, and this can be linked to output gaps between the GDP trend line and the actual GDP
  • In the short run it is possible for an economy to exceed the maximum potential LRAS by allowing factors of production to work overtime or not allow time for maintenance of machinery etc., but this is not possible in the long run
• Keynesian view of LRAS


  • At point B, the LRAS curve is vertical as with the classical view; this is the maximum potential output with current resources and technology, so it is the PPF
  • However, it does not stay vertical: if the curve was vertical this would mean that wages and prices fall when unemployment exists, but Keynes thought wages tend to be 'sticky downwards'
  • When there is high unemployment (the horizontal line on the graph- anything below point A) and a firm wants to recruit, they do not have to offer high wages to attract staff as the LRAS is perfectly elastic at this point
  • At the point between A and B, as employment rises, there are less people looking for jobs and labour is becoming scarce enough that firms have to offer higher wages to attract the best workers, leading to a higher average price level
  • Output becomes more price inelastic until it reaches point B, where an increase in prices no longer affects output as the PPF has been reached
• Factors influencing long run AS

  • Technological advances
  • Changes in relative productivity
  • Changes in education and skills
  • Changes in government regulations
  • Demographic changes and migration
  • Competition policy
• A shift of the LRAS to the right means that economies are able to produce more and is the same as an outward shift of the PPF
• Supply-side shocks to the LRAS curve can occur, for example a huge technological advancement or a war