Transcript Aggregate Supply

IB Economics
What is the Aggregate Supply (AS) curve
and how can it be influenced?
Short Run Aggregate Supply (SRAS)
• SRAS is the relationship between real GDP and the
price level
– SRAS shows how much output the economy can
generate in the short term at each price level
– A rise in the price level should stimulate an expansion of
supply
• We hold the following constant:
– Wage rates for labour (W)
– Other resource prices such as raw material prices and
components
– Long run potential GDP (see later notes on LRAS)
• Changes in aggregate demand cause either a
contraction or an expansion along the SRAS curve
Short Run Aggregate Supply Curve
Price Level
SRAS1
P2
P1
Y1
Y2
Real National Output
Short Run Aggregate Supply Curve
Price Level
SRAS1
A rise in the price level
will cause an expansion
of aggregate supply in
the economy
P2
Producers are
responding to higher
prices (driven up by
increased demand)
P1
Real national output will
increase from Y1 to Y2
Y1
Y2
Real National Output
Shifts in short run aggregate supply
• Changes in unit labour costs (ULCs)
– Unit labour costs are defined as wage costs adjusted for
the level of productivity
• Changes to raw material costs and other
components
– Fluctuations in the world price of oil, copper, aluminum
and other essential inputs in many production processes
– These costs might be affected by movements in the
exchange rate which cause fluctuations in the prices of
imports
• Changes to producer taxes and subsidies levied by
the government as part of their fiscal policy
– Changes in VAT on building materials or duty on fuels
Inward Shift in SRAS
SRAS2
Price Level
SRAS1
P2
Inward shift of SRAS
Less output can be supplied at
each price level
Y2
Y1
RNO
How do changes in wages affect the SRAS?
Sources:
• http://news.bbc.co.uk/2/hi/business/913245.stm
| 8th September 2000
• http://news.bbc.co.uk/2/hi/europe/895217.stm |
24th August 2000
How do changes in wages affect the SRAS?
Price Level
RNO
Long Run Aggregate Supply (LRAS)
• LRAS is located at potential GDP – it represents a
level of real national output in the economy
• Potential GDP is assumed to be independent of the
price level
– The price level is fixed
– Technology does not change
– All resources are fully employed
– The economy is on its production possibilities curve
Long Run Aggregate Supply (LRAS)
• Changes in potential GDP are brought about by:
– Changes in full-employment labour supply available for
production (i.e. more people join the labour force)
– Changes in the stock of capital inputs – affected by the
level of gross capital investment
– Changes in the productivity of factor inputs e.g. higher
labour productivity or an increase in capital productivity
– Advances in the general state of technology
• An outward shift of LRAS signifies an increase in
long-run potential “full-employment” output
Short Run (SRAS) and Long Run Aggregate
Supply (LRAS)
Price Level
LRAS
SRAS
Short run GDP exceeds
potential
Potential GDP
Yp
RNO
Short Run (SRAS) and Long Run Aggregate
Supply (LRAS)
Price Level
LRAS
SRAS
Short run GDP exceeds
potential
Potential GDP
Short run GDP below potential
Yp
RNO
Short Run (SRAS) and Long Run Aggregate
Supply (LRAS)
Price Level
LRAS
SRAS
Positive output gap
Short run GDP exceeds
potential
Potential GDP
Short run GDP below potential
Yp
RNO
Short Run (SRAS) and Long Run Aggregate
Supply (LRAS)
LRAS
Price Level
SRAS
Positive output gap
Short run GDP exceeds
potential
Negative
output gap
Potential GDP
Short run GDP below potential
Yp
RNO
Macroeconomic equilibrium
General
Price Level
LRAS
SRAS
AD
Yp
Real National Output
Macroeconomic equilibrium
General
Price Level
LRAS
SRAS
P1
AD2
AD
Yp
Y2
Real National Output
Inter-relationships between SRAS and
LRAS
General
Price Level
LRAS
SRAS
P1
AD2
AD
Yp
Y2
Real National Output
Inter-relationships between SRAS and
LRAS
General
Price Level
LRAS
SRAS2
SRAS
P2
P1
AD2
AD
Yp
Y2
Real National Output
Inter-relationships between SRAS and
LRAS
General
Price Level
LRAS
SRAS2
SRAS
P2
P1
AD2
AD
Yp
Y2
Real National Output
IB Economics
The Keynesian non-linear
aggregate supply (LRAS) curve
A different way of showing aggregate supply
The Keynesian LRAS Curve
LRAS
Price Level
AD2
AD1
Yfe
The Keynesian LRAS Curve
LRAS
Price Level
AD6
AD5
AD4
AD3
AD2
AD1
Yfe
An Increase in Neo-Classical LRAS with
corresponding increases in AD
Price Level
LAS1
LAS2
LAS3
Ad1
Ad2
Ad3
RNO
How does AD/ LRAS relate to PPF?
LRAS
AD1
AD2
Yfe
Market Orientated Supply-Side Policies
• Reduction in income taxes
• Reduction in corporation taxes
• Reduction in trade union power (early 80’s in UK)
• Reduction / elimination of minimum wages
• Reduction in unemployment benefits
• De-regulation & Privatisation
TAKE A MOMENT TO EVALUATE: Market orientated policies
emphasize the reduced role of the government. Such economic
schools of thought (e.g. the view of the IEA) believe that private
operation is more efficient and will react quicker than government run
organisations. These views are often the basis of political debate.
Interventionist Supply-Side Policies
• Education and training
• Research and development (R&D)
• Provision of infrastructure
• Improved information
TAKE A MOMENT TO EVALUATE: Interventionist policies have
significant opportunity costs associated with them. Time lags will
mean that the policies are likely only to last in the long run.
How does a lack of spending affect the
productive capacity?
Source: http://news.bbc.co.uk/2/hi/business/4197874.stm 30th August 2005
How does a lack of spending affect the
productive capacity?
How does increased spending on education
affect the LRAS?
Source:
http://news.bbc.co.uk/2/hi/business/2
029708.stm | 6th June 2002
TAKE A MOMENT TO
EVALUATE: Many supply
side policies take a long time
to come into affect and cost
huge sums of money. Think
how long it will take for this
policy to come into affect and
as a policy maker does this
mean that you need some
short run tools too? Keynes
said that “In the long run we
are all dead.” I would tend to
agree with him.
How does increased spending on education
affect the LRAS?
Tasks
Today’s Classwork
• Complete student workpoint 17.2 (page 182)
• Complete SRQ # 2 (page 185)
• Complete SRQ # 3 (page 185)
Homework
• Plan Essay Question # 1 (Page 185)
• Read Essential of Economics 4th Ed., Sloman J.
Pages 260 - 264 (available in the library or
photocopy)