(2.3) Aggregate Supply

• Aggregate supply


  The volume of goods and services produced within the economy at a given price level. It indicates the ability of an economy to produce goods and services and 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
  • The curve is 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
• Movement and shifts


  A change in price level will lead to a movement along the curve (contraction or expansion), but a shift in the curve is caused by a range of other factors
• 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
• 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
• Classical 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 full capacity output i.e. where all resources are being fully utilised
  • 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
  • The vertical AS curve is based on the classical view that markets tend to correct themselves fairly quickly
• Keynesian LRAS


  • At point B, the LRAS curve is vertical as with the classical view
  • 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' and will not fall below a certain level
• The inflation the UK experienced after Brexit was caused by the fall in the pound, which pushed import prices up and led to cost-push inflation
• Keynes expressed the view that if the economy can be in disequilibrium for 20-30 years, it can't be correct to imply the AS curve is vertical
• Keynes came up with his own LRAS curve
• LRAS curve


  • 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. This fall in wages thus makes it worthwhile employing people and so employment increases and the economy returns to full employment
• Wages being 'sticky downwards'

  Wages will not fall below a certain level because: unions are able to prevent wages falling too low, businesses are unwilling to risk demotivation of their staff by offering low wages, workers are unwilling to work unless a certain wage is offered, there may be full employment in one area and unemployment in another area due to lack of labour mobility, the minimum wage means wages cannot fall below a certain level
• LRAS curve


  • 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. These higher wages lead 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
• Shift of the LRAS to the right


  Economies are able to produce more and is the same as an outward shift of the PPF
• 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
• Technological advances


  Improvements in technology shift the LRAS curve to the right, meaning more can be produced. This is because it will speed up production, so more goods can be produced with the same amount of resources. Increased investment in technology, whether this be new technology or current technology, will increase the LRAS as it means that more goods can be produced because there are more machines etc.
• Changes in relative productivity


  The more productive the economy is, the more that will be produced with the given resources. Productivity depends on a range of factors, such as efficiency, skill of labour and technology. Additionally, if the UK is more productive than other countries it will encourage production of that good in the UK, so investment will be increased, and this will increase LRAS
• Changes in education and skills


  A more skilled workforce will be more employable and work quicker and more efficiently within their jobs, so the output per worker will increase, which will shift the LRAS to the right. Education could also be used to improve the occupational mobility of labour which decreases structural unemployment as people are able to switch to new jobs. This will ensure all resources are used efficiently
• Ways government regulations can impact LRAS

  • Increase the size of the workforce
  • Increase research and development
  • Make it easier to set up businesses and increase incentives to be entrepreneurial
  • High regulation on businesses will limit LRAS as it will increase costs and the time taken to undertake tasks, which will reduce output
• Demographic changes and migration

  If immigration is higher than emigration, the population will grow and so therefore there will be more workers which will increase the LRAS. The value and importance of this immigration will depend on the age of the immigrants and their skills. In an ageing population or a young population, LRAS will be lower as the working population is smaller so therefore less goods can be produced. The more people who are of working age, the higher the LRAS
• Competition policy


  The government can promote competition between businesses and markets which will force them to improve the quality of their goods or lower prices. In order for businesses to do this and still make a profit, they have to improve their efficiency and this efficiency will mean that more goods and services can be produced, so LRAS will increase. However, less competition can sometimes be beneficial if it encourages investment and innovation. For example, copyright laws mean that businesses' new ideas can't be copied which will encourage them to do more research as they know they will be the ones who benefit in terms of higher profits