Aggregate Supply

The Sum of all planned domestic production at a

given general price level per period

SRAS/LRAS?

• There are two types of Aggregate Supply• Short Run Aggregate Supply • Long Run Aggregate Supply

Short Run Aggregate Supply

• This assumes that prices of all factors are fixed

• As you supply more, more must be paid

Shifts in the Curve

• Like AD the SRAS curve can shift.• If there is a shift to the left it can mean

costs of production may have risen (Cost Push Inflation)

• Should there be a shift to the right, costs of production may fallen.

• It is easier to look at a question of SRAS and see if what has happened will affect the cost of production.

Shifts in the Curve

Costs Up

Costs Down

Long Run Aggregate Supply

• In the long run wage rates and input prices will change.

• You need to know the two main view on LRAS– Neo-Classical View– Keynesian View

Neo-Classical View LRAS

• This states that LRAS is a vertical line. • These economists argue that there is a

tendency to full employment as wages will fall until full employment is restored.

• This means that they believe the economy in the long run will operate at full employment

Neo-Classical View LRAS

Keynesian LRAS Curve

• The curve is different• They believe that in the Long Run

unemployment will always exist as wages are sticky downwards

• This means that should AD fall, workers will resist cuts in pay and the economy will not return to full employment as the classical economists say

Keynesian LRAS Curve • Keynesians say that at low levels of output

there is low levels of employment, the curve will be horizontal

• This is due to spare capacity in the economy• This means output can be increased without

a cost rise• Once pressure is placed on the capacity and

inputs become in short supply such as skilled workers , the curve slopes up

• Once you reach full employment you cannot raise output anymore so the curve is vertical

Keynesian LRAS Curve

Shifts in the Curve

• Changes to LRAS are changes to the productive potential of the economy

• Increase, shift right– Quality of Inputs are increased e.g. Education

in the Labour Market– Quantity of Inputs are increased e.g. size of

labour force

• Decrease, shift left

Case Study

• After the Second World War, many of Britain’s soldiers were dead, which meant that the productive capacity of the economy was damaged due to a reduction in the labour force

Case Study

• However in 1964 the Baby Boom was fully realised on the size of the labour force