2.3 Aggregate Supply

Question 1

What is AS?

Answer 1

aggregate supply is the total supply of goods/services produced within an economy at a specific price level at a given time

Question 2

Why is the AS curve upward sloping? 2

Answer 2

• AS is the combined supply of all individual supply curves In an economy which are also sloping upwards
• as rea GDP increase. firms have to spend more to increase production. Increased costs result in higher average prices

Question 3

When does shifts of the SRAS curve occur?

Answer 3

When there is a change in the condition of supply in an economy
- changes to the costs of production or productivity changes

Question 4

How does shifts in LRAS occur?

Answer 4

Influenced by a change in the productive capacity of the economy
- productive capacity is changed by changes in the quantity or quality of the factors of production
- when production capacity changes, it is equivalent to a shift in the PPF

Question 5

What are the factors that influence SRAS? 3

Answer 5

• changes in costs of raw materials and energy
• changes in exchange rate (ER)
• changes in tax rates?

Question 6

How does increases in costs of raw materials influence SRAS?

Answer 6

• As the price of import costs rise
• fewer goods/services can be produced with the same amount of money
• SRAS decrease
• AS curve shifts to the left

Question 7

How does decreases in costs of raw materials influence SRAS?

Answer 7

• as the price of input costs decrease
• more goods/services can be produced with the same amount of money
• SRAS increased
• AS curve shifts to the right

Question 8

How does a depreciation of the ER influence SRAS?

Answer 8

• producers import raw materials
• weaker currency = more expensive imports
• more expensive imports = increase in input costs
• higher costs = less output
• SRAS decreases, shifts leftr

Question 9

How does an appreciation of ER influence SRAS?

Answer 9

• producers often import raw materials
• stronger currency = cheaper imports
• cheaper imports = decrease in input costs
• lower costs = more output
• SRAS increases, shifts right

Question 10

How does decrease in tax rates influence SRAS?

Answer 10

• taxes represent an additional cost for firms
• decreasing taxes = decrease in costs
• lower costs = more output
• SRAS increases, shifts right

Question 11

How does increase in tax rates influence SRAS?

Answer 11

• taxes represent an additional cost for firms
• increasing taxes = increase in costs
• higher costs = less output
• SRAS decreases, shifts less

Question 12

What is LRAS?

Answer 12

Long run aggregate supply

Question 13

What is LRAS influenced by?

Answer 13

the change in productive capacity of the economy
- changed by changes to quantity or quality of the factors of production

Question 14

What do classicists believe about LRAS? 3

Answer 14

• believe that LRAS is perfectly inelastic at a point of full employment of all available resources
• this point corresponds to the maximum possible output on a PPF
• thus believing in the long-run an economy will return to the full employment level of output

Question 15

What did Keynes believe about LRAS?

Answer 15

• supply is elastic at lower levels of output was there is a spare production capacity in the economy
  
  • struggling firms will increase output without raising prices
• supply is perfectly inelastic at a point of full employment of all available resources
  
  • the closer the economy gets to this point the price inflation will occur as firms compete for scarce resources

Question 16

What does the Keynesian view suggest about unemployment?

Answer 16

• the economy will not always self-correct
• return to the full employment level of output
• it can get stuck at an equilibrium well below the full employment level of output (Great Depression)

Question 17

What does the Keynesian view believe about government expenditure?

Answer 17

the government is to increase expenditure so as to shift aggregate demand and change the negative ‘animal spirits’ in the economy

Question 18

How is a Keynesian LRAS shown diagrammatically?

Answer 18

• long term output of the economy using all factors of production is shown at Yf
• the economy is initially at equilibrium at the intersection of AD and LRAS
• a slowdown reduces AD from AD1 to AD2
• this creates a recessionary gap Y1 - Yf
  The low output leads to high unemployment and low confidence in the economy
  
  • stops further investment and further reduces consumption.

Question 19

What causes shifts in the LRAS?

Answer 19

Any factor that changes the quantity or quality of a factor of production
- corresponds to an outward or inward shift of the PPF

Question 20

What Factors influence LRAS? (6)

Answer 20

• technological advances
• changes in relative productivity
• changes in education and skills
• changes in government regulation
• demographic changes and migration
• competition policy

Question 21

How does technological advances influence LRAS?

Answer 21

• these improve quality of factors of production
  -e.g. development of metals

Question 22

How does changes in relative productivity influence LRAS?

Answer 22

• process innovation often results in productivity improvement

Question 23

What is productivity?

Answer 23

Output per unit of input used

Question 24

How does changes in education and skills influence LRAS?

Answer 24

over time this increases the quality of labour in an economy

Question 25

How does changes in government regulation influence LRAS?

Answer 25

improves quantity of the factors of production
- e.g. being able to produce more

Question 26

How does demographic changes and migration influence LRAS?

Answer 26

a positive net birth rate or positive net migration rate will increase the quantity of labour

Question 27

How does competition policy influence LRAS?

Answer 27

regulating industries to prevent monopoly power resulting in more firms supplying goods/services in an economy
- increasing the potential output of an economy