CH27 Aggregate supply

Question 1

What does the aggregate supply curve show?

Answer 1

it shows the level of output in the whole economy at any given level of average prices

Question 2

What happens to the short-run aggregate supply curve when there is an increase in firms costs of production

Answer 2

the short-run AS shifts to the left

Question 3

What does the long-run aggregate supply curve show?

Answer 3

it shows the productive capacity of the economy at any given price level (just like the PPF)

Question 4

What causes shifts in the long-run AS curve?

Answer 4

caused by changes in the quantity or quality of factors of production or the efficiency of their use

Question 5

Why is it called the aggregate supply curve?

Answer 5

because it is the sum of all the industry supply curves in the economy. It shows how much output firms wish to supply at each level of price

Question 6

What is the short run defined as?

Answer 6

defined as the period when money wage rates and the prices of all other factor inputs in the economy are fixed, so firms tend to respond to increases in demand by working their labour force more intensively, for instance through overtime.

Question 7

What do some firms do after they introduce overtime

Answer 7

in many sectors of the economy where competition is imperfect and where firms have the power to increase their prices, the rise is labour costs (due to overtime so that supply can increase) will lead to a rise in prices.
-it only needs prices to rise in some sectors of the economy for the average price level in the economy to rise

Question 8

So in the short term what may an increase in output by firms lead to?

Answer 8

in the short term, and increase in output by firms is likely to lead to an increase in their costs which in turn will result in some firms raising their prices

Question 9

is the increase in prices likely to be big or small? and why? and what elasticity is the short-run AS curve?

Answer 9

-the increase in prices is likely to be small because, given constant prices (e.g. wage rates) for factor inputs, the increase in costs (e.g. wage earnings) are likely to be fairly small too.
-therefore the short-run AS curve is relatively price elastic

Question 10

If demand and real output fall in the short run how will some firms react?

Answer 10

some firms in the economy will react by cutting their prices to try to stimulate extra orders.
-however, the opportunities to cut prices will be limited
-firms will be reluctant to sack workers and their overheads will remain the same, so their average cost and marginal cost will barely be altered.
-again the aggregate supply curve is relatively price elastic. So the movement along the curve, caused by a fall in real output will lead to a small fall in the average price level.

Question 11

What does the short-run aggregate supply curve show?

Answer 11

shows the relationship between aggregate output and the average price level, assuming that money wage rates in the economy are constant

Question 12

What are the 5 factors that can cause the short-run AS curve to shift?

Answer 12

-wage rates
-raw material prices
-taxation
-exchange rates
-productivity

Question 13

How do wage rates affect the SRAS curve?

Answer 13

-an increase in wage rates will result in firms facing increased costs of production. Some firms will respond by increasing prices. So at any given level of output, a rise in wage rates will lead to a rise in the average price level. Therefore the SRAS curve shifts to the left.

Question 14

How do raw material prices affect the SRAS curve?

Answer 14

-a general fall in the prices of raw materials may occur. Perhaps world demand for commodities falls, or perhaps the valye of the pound rises, making the price of imports cheaper.
-a fall in the price of raw materials will lower industrial costs and will lead to some firms reducing the prices of their products. Hence there will be a shift in the short-run aggregate supply curve downwards (right)

Question 15

How does taxation affect the SRAS curve?

Answer 15

an increase in the tax burden on industry will increase costs. Hence the SRAS schedule will be pushed upwards (left)

Question 16

How do exchange rates affect the SRAS curve?

Answer 16

-if the exchange falls, the price of imported goods is likely to rise. This will lead to an increase in prices throughout the economy. So a fall in the exchange rate will shift the SRAS curve up (left).
-conversely, a rise in the exchange rate will lead to a fall in the price of imported goods. This will lead to a fall in prices throughout the economy. So a rise in the exchange rate will shift the SRAS curve downwards (right)

Question 17

How does productivity affect the SRAS curve?

Answer 17

productivity is output per unit of input employed. So labour productivity is output per worker. Capital productivity is output per unit of capital employed.
-increases in productivity over time, for example because of a better-educated workforce or improved technology, will lead to an increase in long-run supply. However, it will also reduce costs of production in the short run, so shifting the short run aggregate supply curve downwards (right)

Question 18

When is a supply-side shock said to have occurred?

Answer 18

when there is a large change in wage rates, raw material prices or taxation

Question 19

Why is the long-run aggregate supply curve likely to shift over time?

Answer 19

because the quantity or quality of economic resources changes over time, as does the way in which they are combined. These changes bring about changes in the productive potential of an economy

Question 20

What are the 10 factors that can cause the long-run aggregate supply curve to shift?

Answer 20

-technological advances
-changes in relative productivity to competing economies
-changes in education and skills
-changes in government regulations
-demographic changes and migration
-competition policy
-enterprise and risk taking
-factor mobility
-economic incentives
-the institutional structure of the economy

Question 21

How do technological advances affect the LRAS curve?

Answer 21

-improvements in tech allow new products to be made or existing products to be produced with fewer resources. Increases in capital productivity shift the LRAS curve to the right

Question 22

how do changes in relative productivity to competing economies affect the LRAS curve?

Answer 22

-an increase in the UK productivity of a good relative to other world economies will encourage production of that good in the UK. Firms will invest, shifting the LRAS curve to the right.
-the LRAS curve of the economy will increase if there is increased specialisation between economies, allowing production to be located in the cheapest most efficient place in the world economy

Question 23

how do changes in education and skills affect the LRAS curve?

Answer 23

improvements in education and skills of workers will raise their productivity, so increasing long run aggregate supply

Question 24

How do changes in gov regulations affect the LRAS curve?

Answer 24

-changes in gov regulations can lead to an increase in LRAS. For example, making it simpler to set up a company could encourage more entrepreneurs to create companies, output and jobs.
-imposing regulations on supermarkets to deal fairly with their suppliers could reduce the number of suppliers going into administration and reducing the productive potential of the economy

Question 25

How do demographic changes and migration affect the LRAS curve?

Answer 25

-demographic (population) changes that increase the size od the workforce are likely to increase LRAS. For example, an increase in immigration of people of working age will increase the productive potential of the economy. An aging population where the number of people of working age is shrinking will reduce the LRAS

Question 26

How does competition policy affect the LRAS curve?

Answer 26

-gov policies which increase competition amongst firms is likely to increase LRAS. Competition is likely to force firms to be more productive and reduce their costs, or more innovative producing new products and new ways of producing goods and services.
-however, less competition can sometimes be beneficial if it encourages investment and innovation. For example, without patent and copyright laws, firms that spent on research and development would find their results being copied by other firms

Question 27

How does enterprise and risk taking affect the LRAS curve?

Answer 27

economies where enterprise and risk taking are encouraged are likely to see increases in their LRAS. the creation of new firms will increase output now and in the future when some of them grow in size.
-enterprise and risk taking also encourage competition which in itself might increase LRAS

Question 28

How does factor mobility affect the LRAS curve?

Answer 28

-increases in factor mobility are likely to increase the LRAS. For example, in the EU, movements of workers from Poland or Estonia to work in Germany or the UK are likely to increase the productive potential of Germany, the UK and the EU

Question 29

How do economic incentives affect the LRAS curve?

Answer 29

improvements in economic incentives can increase aggregate supply. For example, giving tax incentives for the unemployed to take a job can reduce unemployment and increase output

Question 30

How does the institutional structure of the economy affect the LRAS curve?

Answer 30

-the institutional structure of an economy refers to the political system, laws, the educational system, the banking system, the framework of morality and behaviour and other systems which determine how an economy works.
-for example, if there is a strong tradition of bribery and corruption within an economy, then making the system accord more with the rule of law is likely to increase LRAS.
-equally, if the banking system is weak, saving and borrowing will be affected. A stronger baking system can encourage households to save and make funds more available to firms, again increasing LRAS