Aggregate Supply- SRAS and LRAS (Classical and Keynes)

Question 1

What are the two main types of Aggregate Supply curves?

Answer 1

Short-Run Aggregate Supply (SRAS) and Long-Run Aggregate Supply (LRAS).

Question 2

What is SRAS?

Answer 2

SRAS shows the relationship between the price level and output when some input prices (like wages) are sticky.

Question 3

Why is SRAS upward sloping?

Answer 3

As prices rise, firms are willing to produce more (in the short run) because higher prices mean higher profits.

Question 4

What can cause SRAS to shift?

Answer 4

Changes in the cost of production (COP) such as wages, raw materials, and energy prices.

Question 5

What happens to SRAS if wages rise?

Answer 5

COP increases → SRAS shifts left.

Question 6

What happens to SRAS if production costs fall?

Answer 6

SRAS shifts right, as it’s cheaper to produce goods.

Question 7

What does LRAS represent in the Classical view?

Answer 7

A vertical line at full employment (YFE) — the economy always returns to this level in the long run.

Question 8

What determines the position of LRAS (Classical)?

Answer 8

The quantity and quality of factors of production — not the price level.

Question 9

What is Full Employment Level of Output (YFE)?

Answer 9

The maximum sustainable output the economy can produce with existing resources.

Question 10

What happens to SRAS if wages fall?

Answer 10

Cost of production (COP) decreases → SRAS shifts right.

Question 11

What happens to SRAS if wages rise?

Answer 11

COP increases → SRAS shifts left.

Question 12

How do raw material prices affect SRAS?

Answer 12

If prices rise → COP increases → SRAS shifts left

If prices fall → COP decreases → SRAS shifts right

Question 13

How do oil prices affect SRAS?

Answer 13

Oil price rises → COP rises → SRAS shifts left

Oil price falls → COP falls → SRAS shifts right

Question 14

How do business taxes (e.g., VAT) affect SRAS?

Answer 14

Higher VAT → COP rises → SRAS shifts left

Lower VAT → COP falls → SRAS shifts right

Question 15

How does a strong exchange rate affect SRAS?

Answer 15

Imports become cheaper → lower COP for firms using imported inputs → SRAS shifts right

Question 16

How does a weak exchange rate affect SRAS?

Answer 16

Imports become more expensive → COP increases → SRAS shifts left

Question 17

What is a supply-side shock?

Answer 17

A sudden and unexpected change in SRAS due to major events like oil price spikes or natural disasters.

Positive shock → SRAS shifts right

Negative shock → SRAS shifts left

Question 18

What do Classical economists believe about LRAS?

Answer 18

LRAS is vertical — the economy will always return to full employment output (YFE) in the long run.

Question 19

What does the vertical LRAS represent in the Classical model?

Answer 19

The economy’s maximum sustainable output using all resources efficiently (YFE/full employment).

Question 20

What is the natural rate of unemployment in the UK (as of your notes)?

Answer 20

About 4.5% — consistent with full employment in the Classical model.

Question 21

What causes LRAS to shift right?

Answer 21

Increase in quantity or quality of factors of production (FoP)

Improvement in productivity

Better education/training, investment in capital

Technological advances

Improved productive efficiency (same resources used more effectively)

Question 22

What happens to LRAS if productivity or factor quality falls?

Answer 22

LRAS can shift left, reducing the economy’s potential output.

Question 23

What are the main factors that shift LRAS to the right?

Answer 23

Improved quality of labour

Investment in capital

Better infrastructure

Increase in quantity of labour

Greater competition

Question 24

How does improving the quality of labour shift LRAS?

Answer 24

Training, education, and health improvements boost labour productivity → LRAS shifts right.

Question 25

How does capital investment affect LRAS?

Answer 25

Spending on R&D, technology, new machines or factories increases productive efficiency → LRAS shifts right.

Question 26

How does better infrastructure shift LRAS?

Answer 26

Efficient transport systems reduce costs and time for businesses → boosts long-run productivity → LRAS shifts right.

Question 27

How can labour quantity be increased?

Answer 27

Immigration Lower income taxes or benefits reform to encourage work → More active workers → LRAS shifts right

Question 28

How does increased competition shift LRAS?

Answer 28

Deregulation, privatization, and trade liberalization push firms to cut costs and innovate → improves efficiency → LRAS shifts right.

Question 29

How do natural resource discoveries affect LRAS?

Answer 29

Discovering more land or raw materials increases the quantity of factors of production → LRAS shifts right.

Question 30

What is the impact of technological progress on LRAS?

Answer 30

Boosts productivity and efficiency across sectors → LRAS shifts right.

Question 31

What causes LRAS to shift left?

Answer 31

Decline in labour productivity Capital depreciation (e.g., lack of investment) War or conflict Natural disasters Global pandemics Hysteresis (long-term unemployment discouraging workers) Emigration of working-age people

Question 32

How does war/conflict affect LRAS?

Answer 32

Destroys infrastructure and capital, reduces labour force → LRAS shifts left.

Question 33

How do pandemics reduce LRAS?

Answer 33

Cause death or illness, reduce both quantity and productivity of labour → LRAS shifts left.

Question 34

What is hysteresis in labour markets?

Answer 34

A situation where long-term unemployment causes workers to permanently leave the labour force → reduces LRAS.

Question 35

What is the main disagreement between Keynesian and Classical economists regarding LRAS?

Answer 35

Keynesians disagree with the vertical LRAS of the Classical model. They argue the economy can be in long-term equilibrium below full employment (YFE).

Question 36

What does the Keynesian LRAS curve look like?

Answer 36

It is bendy or L-shaped: Horizontal at low output (spare capacity) Upward sloping as resources become scarce Vertical at full employment (YFE)

Question 37

Why is the Keynesian LRAS curve flat at low levels of output?

Answer 37

There’s spare capacity in the economy — high unemployment, idle capital and land. Firms can increase output without raising prices.

Question 38

What happens in the upward-sloping part of the Keynesian LRAS curve?

Answer 38

As spare capacity is used up, output increases begin to put upward pressure on prices, leading to demand-pull inflation.

Question 39

What happens at the vertical section of the Keynesian LRAS?

Answer 39

The economy reaches full employment (YFE). No further output is possible without inflation, just like in the Classical model.

Question 40

Why do Keynesians reject the idea that the economy always returns to full employment?

Answer 40

They argue that without government intervention, economies can get stuck in underemployment equilibria due to sticky wages and weak demand.

Question 41

What happens to the inflation rate in a deep recession according to Keynesian economics?

Answer 41

The inflation rate stays constant as the economy operates below full capacity (YFE), with excess labour and capital available.

Question 42

How does the use of spare capacity affect wages and costs in the Keynesian model?

Answer 42

As spare capacity is used up (closer to YFE), labour becomes scarcer. Wages rise to attract workers, increasing costs for firms. Capital becomes scarcer, leading to higher costs for capital (e.g., interest rates).

Question 43

What happens when wages and capital costs rise in the Keynesian model?

Answer 43

Increased wages and capital costs push up overall production costs, which are passed on as higher prices (inflation).

Question 44

What happens when the economy reaches the vertical part of the Keynesian LRAS?

Answer 44

The economy reaches full employment (YFE). At this point, output can no longer increase sustainably without causing inflationary pressure.

Question 45

How does the Keynesian LRAS differ from the Classical view regarding inflation and full employment?

Answer 45

Keynesians believe the economy can operate below full employment for long periods without inflation. Classicals believe the economy will always return to full employment in the long run and that any output beyond YFE will lead to inflation.