Aggregate supply/classical/Keynesian

What is aggregate supply (AS)?

The total amount of goods and services produced within an economy at a given price level in a given time period.

What is short-run aggregate supply (SRAS)?

The amount firms are willing and able to produce at different price levels in the short run. It is upward sloping and strongly affected by costs of production.

Why is SRAS upward sloping?

As the price level rises relative to firms' costs, production becomes more profitable, encouraging firms to increase output.

What are the main determinants of SRAS?

Wages, raw material and commodity prices, exchange-rate movements affecting import costs, and indirect taxes or subsidies.

What happens to SRAS if wages rise?

Firms' production costs rise → profitability at each price level falls → SRAS shifts left.

What happens to SRAS if imported raw materials become cheaper?

Firms' production costs fall → firms can supply more at each price level → SRAS shifts right.

How can exchange-rate depreciation affect SRAS?

Imported inputs become more expensive → firms' costs rise → SRAS shifts left.

How does an indirect tax affect SRAS?

Production costs rise → SRAS shifts left.

How can a subsidy affect SRAS?

Firms' effective production costs fall → SRAS shifts right.

What is long-run aggregate supply (LRAS)?

The economy's productive capacity or potential level of output.

What is the classical view of LRAS?

LRAS is perfectly vertical at the full-employment level of output.

Why is classical LRAS vertical?

Classical economists assume wages and prices are flexible and the economy self-corrects towards full employment, so changes in AD affect prices rather than long-run real output.

What can shift classical LRAS?

A change in the quantity or quality of factors of production.

Can a change in aggregate demand shift classical LRAS?

No. LRAS shifts because productive capacity changes, not because AD changes.

Give examples of factors that can shift LRAS right.

A larger labour force, improved education and skills, greater capital investment, technological progress or increased productivity.

How does the classical model say an economy self-corrects after a downturn?

AD falls → output falls and unemployment rises → wages fall → firms' costs fall → employment and output recover → economy returns towards full-employment output.

What is the Keynesian view of LRAS?

LRAS has three sections: relatively flat at low output, upward sloping as the economy approaches capacity, and vertical at full capacity.

Why is the first section of Keynesian LRAS relatively flat?

The economy has substantial spare capacity → firms can increase output without creating much upward pressure on wages or prices.

Why does Keynesian LRAS become upward sloping?

As spare capacity falls, bottlenecks and shortages of factors of production emerge → increasing output causes progressively larger cost and price increases.

Why is the final section of Keynesian LRAS vertical?

The economy has reached full productive capacity → real output cannot rise further using existing factors of production.

What are sticky wages and prices?

Wages and prices that adjust only slowly, particularly downwards.

Why do sticky wages and prices matter in Keynesian economics?

They mean the economy may remain below full employment following a fall in AD rather than automatically self-correcting quickly.

Why might Keynesian economists support government intervention during a recession?

Sticky wages and prices can leave the economy stuck below full employment → expansionary fiscal or monetary policy can raise AD → negative output gap closes → real output and employment rise.

What is the main difference between classical and Keynesian views of LRAS?

Classical economists argue flexible wages and prices cause automatic self-correction to full employment. Keynesians argue sticky wages and prices can allow prolonged spare capacity, meaning government intervention may be necessary.

What happens when AD increases on the flat section of Keynesian LRAS?

Real output rises considerably with relatively little increase in the price level because there is substantial spare capacity.

What happens when AD increases on the upward-sloping section of Keynesian LRAS?

Both real output and the price level rise because spare capacity is becoming limited.

What happens when AD increases on the vertical section of Keynesian LRAS?

The price level rises but real output cannot increase because the economy is already at full productive capacity.

Draw the classical LRAS diagram.

Draw LRAS as a vertical line at the full-employment or potential level of output.

Draw the Keynesian LRAS diagram.

Draw a curve that is relatively flat at low output, becomes upward sloping as capacity is approached, and eventually becomes vertical at full capacity.