ib economics what is the aggregate supply (as) curve and how can it be influenced?
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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
Real National Output
Price Level SRAS1
P1
Y1
P2
Y2
Short Run Aggregate Supply Curve
Real National Output
Price Level SRAS1
P1
Y1
P2
Y2
A rise in the price level will cause an expansion of aggregate supply in the economy
Producers are responding to higher prices (driven up by increased demand)
Real national output will increase from Y1 to Y2
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
Price LevelSRAS1
Y2
P2
Y1
SRAS2
RNO
Inward shift of SRAS
Less output can be supplied at each price
level
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
RNOYp
SRAS
LRAS
Potential GDP
Short run GDP exceeds potential
Short Run (SRAS) and Long Run Aggregate Supply (LRAS)
Price Level
RNOYp
SRAS
LRAS
Potential GDP
Short run GDP exceeds potential
Short run GDP below potential
Short Run (SRAS) and Long Run Aggregate Supply (LRAS)
Price Level
RNOYp
SRAS
LRAS
Potential GDP
Short run GDP exceeds potential
Short run GDP below potential
Positive output gap
Short Run (SRAS) and Long Run Aggregate Supply (LRAS)
Price Level
RNOYp
SRAS
LRAS
Potential GDP
Short run GDP exceeds potential
Short run GDP below potential
Positive output gap
Negative output gap
Macroeconomic equilibrium
GeneralPrice Level
Real National OutputYp
SRAS
LRAS
AD
Macroeconomic equilibrium
GeneralPrice Level
Real National OutputYp
SRAS
LRAS
AD
AD2
P1
Y2
Inter-relationships between SRAS and LRAS
GeneralPrice Level
Real National OutputYp
SRAS
LRAS
AD
AD2
P1
Y2
Inter-relationships between SRAS and LRAS
GeneralPrice Level
Real National OutputYp
SRAS
LRAS
AD
AD2
P1
Y2
SRAS2
P2
Inter-relationships between SRAS and LRAS
GeneralPrice Level
Real National OutputYp
SRAS
LRAS
AD
AD2
P1
Y2
SRAS2
P2
IB Economics
The Keynesian non-linear aggregate supply (LRAS) curve
A different way of showing aggregate supply
The Keynesian LRAS Curve
Price LevelLRAS
Yfe
AD1AD2
The Keynesian LRAS Curve
Price LevelLRAS
AD1AD2
AD3AD4
AD5
AD6
Yfe
An Increase in Neo-Classical LRAS with corresponding increases in AD
Price Level
RNO
LAS1 LAS2 LAS3
Ad1 Ad2Ad3
How does AD/ LRAS relate to PPF?
LRAS
Yfe
AD1
AD2
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/2029708.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)