4.2.2.5, 4.2.2.6 Aggregate Supply

Question 1

Short-Run Aggregate Supply Definition

Answer 1

The amount that will be supplied for the period of time in which at least one factor of production is fixed.

Question 2

Long-Run Aggregate Supply Definition

Answer 2

The amount that will be supplied for the period of time when all factors of production are variable, equivalent to the productive potential of the economy.

Question 3

Factors causing a Shift in SRAS

Answer 3

1. Changes to Costs of Production
   - Wages
   - Raw Materials
   - Labour Productivity
   - Interest Rates
2. Changes to taxation rates that affects firms, subsidies and imported costs.
   - e.g. Corporation tax, VAT, Business rates
   - Costs of imported components
   - Scale of subsidies to industries
3. Supply shocks.
4. Tariffs and Quotas.
5. Price of commodities.

Question 4

Classical LRAS Curve Theory

Answer 4

• An economy will always produce the maximum that its factor resources will allow.
• Markets always function efficiently over the long run.

Question 5

Keynesian LRAS Curve Theory

Answer 5

• An economy could be in equilibrium below full employment. Based of research about the Great Depression.
• Markets can take time to clear and you can get long periods of unemployment.
• Markets are sticky downwards (labour markets don’t clear).
• Negative multiplier effect.
• Paradox of thrift, when people lose confidence, they save more, causing a further fall in demand.

Question 6

Elasticity of Aggregate Supply

Answer 6

• When spare capacity is high, AS will be elastic, as firms can meet a rise in output without inflation.
• The elasticity of the AS curve falls as output increases due to:
  1. Spare Capacity declining.
  2. Diminishing returns in production.
  3. Resource shortages as the economy approaches full employment.

Question 7

Classical and Keynesian LRAS Differences

Answer 7

Fiscal Policy:
K - In recession, expansionary fiscal policy can stimulate economic activity.
C - Fiscal poicy causes in long-term increase inreal output.
Wage Rigidity:
K - Wages can be sticky downwards causing unemployment.
C - In absence of min wages/ trade unions wages are flexible.
Unemployment:
K - Demand-deficient unemployment big causes.
C - Tend to emphasis supply-side unemployment.
Phillips Curve:
K - There is a tradde off between unemployment and inflation.
C - Only a trade-off in the short-term.
Government Borrowing:
K - In recession, governments should borrow more to offset fall in private spending.
C - Government should seek to run a balanced budget.
Crowding Out:
K - No crowding out in a recession.
C - Government borrowing causes more crowding out.

Question 8

Factors Affecting LRAS

Answer 8

1. Change in quantity or quality of factors of production.
2. Technological Advances.
3. Changes in Education and Skills.
4. Changes in Relative Productivity.
5. Changes in Government /Competition Policy.
6. Demographic Changes and Migration.
7. The Institutional Structure of the Economy.

Question 9

How Technological Advances affect LRAS

Answer 9

• Reduce the cost of production and help to increase productivity.
• Leads to an increase in supply as firms already in the industry can increase production to earn higher profits.
• Other firms might enter the industry.

Question 10

How Changes in Education and Skills affect LRAS

Answer 10

• An increase in the quality of the labour force enhances productivity and therefore LRAS will increase.
• Training and education of the workforce should lead to an increase in efficiency and skills.
• A higher skilled workforce is better able to innovate and continually improve production processes.

Question 11

How Changes in Relative Productivity affect LRAS

Answer 11

• The UK lags behind its competitors in terms of productivity.

Question 12

How Changes in Government Regulations/Competition Policy affect LRAS

Answer 12

• Governments will often use regulatory frameworks to improve the level of competition in different markets.
• If successful, then greater competition can drive efficiency gains amongst firms as they strive to maximise their profits, encourages innovation provides greater choice and quality.

Question 13

How Demographic Changes and Migration affect LRAS

Answer 13

• Changes in population impact LRAS.
• For example, an ageing population has led people to live longer without working.
• An increase in the sixe of the labour force through immigration will increase productive potential.