Aggregate Supply

Test yourself on Aggregate Supply

Test your knowledge with free interactive questions on Seneca — used by over 10 million students.

Short Run Aggregate Supply Curve

AS is the total quantity of output firms will produce and sell at a given price level.

Short run aggregate supply

The SRAS curve is upward sloping.
The SRAS curve shows the total quantity firms will produce at each price level.
The curve shows how suppliers will react to a higher price level for final outputs of goods and services, holding inputs constant.
This is represented by the increasingly upwards sloping curve.

Movement along the SRAS

Movement along the SRAS curve is caused by a change in the average price level.

Shifts in the SRAS curve

Shifts in the SRAS curve can be caused by several factors:
- Business costs: labour and raw material costs may rise.
- Exchange rates: the exchange rate may lead to higher prices of imports.
- The government can impose taxes which can increase the cost of producing goods or services.

Supply side shock

A supply-side shock is anything (positive or negative) that causes SRAS to change.
Examples could be a bad harvest, technological improvement, or a new mineral discovery.
A rise in global oil prices will cause the SRAS to shift left as imported costs of production rise.
This will lead to the equilibrium level of real GDP falling, and the General Price Level to rise - that is, cost-push inflation, potentially causing the purchasing power of consumers to fall if wages have not caught up.

Difference between short run and long run

In the short run, at least one of the 'factors of production' (labour, land, enterprise or capital) are fixed.
In the long run, all factors of production are variable.
In the long run, the economy is operating at full employment (this is known as the natural rate of unemployment).

Long-Run Aggregate Supply

Underlying economic growth is shown by a rightward shift in the long-run aggregate supply curve (LRAS). This represents an increase in the productive capacity of the economy.

Long-run factors

The most important factor to shift LRAS outwards (to the right) is productivity growth. But it could also be an increase in the amount of factors of production (e.g. population growth).
Productivity could mean output per unit of labour (per worker).

Other long-run factors

Technology - e.g. faster broadband.
Infrastructure - e.g. better trains and roads and ports would mean goods and services can be produced and transported more efficiently.
Enterprise.
Cultural attitudes - e.g. if in some countries women were permitted to participate in the labour market, this would shift LRAS to the right.

Other long-run factors cont.

Factor mobility - e.g. the more occupational and geographical mobility there is in an economy, the more the LRAS will shift out.
Economic incentives - e.g. if corporation tax is lowered to attract foreign firms or domestic firms invest more, then the LRAS will shift out.

Using AS/AD to show equilibrium

The intersection between the AD and AS curves shows the equilibrium price level and real GDP of the economy.
At a low price level, firms have little incentive to produce, but consumers are willing to buy.
As the price level rises (also known as inflation), AS rises and AD falls until equilibrium is reached.

Different Models of LRAS

There are two models for the LRAS curve. The Keynesian Long-Run Aggregate Supply curve curves upwards. The Classical LRAS is vertical.

Classical LRAS

The Classical LRAS curve is vertical.
In the long run, when all of an economy's factors of production are being used, the economy is operating on its PPF and is at full capacity. An increase in price, cannot incentivise an increase in output, because output in the economy is maxed out.
The Classical LRAS can be shifted by an increase in the amount or quality of each factor of production.

Classical LRAS

Keynesian LRAS

Keynesian economists build models that have an LRAS that curves upwards.
At low quantities of output, there is a lot of spare capacity. Increases in output use up this spare capacity and they are not inflationary. Unemployed workers are hired and unused factors of production are used.
As output rises, supply starts to become a 'limiting factor'. There could be labour shortages, capital shortages or a shortage of raw materials. This is inflationary, but not impossible to increase output.
Eventually, the economy is at Y_full and all factors of production are being used. The economy is at full output.