Chapter 15: Aggregate Supply

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6 Terms

1
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Aggregate supply

is the total amount of goods and services that all industries in the economy will produce at every given price level.

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Things that cause a shift in aggregate supply curve

changes in the FOP:

  • change in wage rates

  • changes in costs of raw materials

  • change in the price of imports

  • change in gov taxes or subsidies


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Keynesian LRAS curve

  • Phase 1 – Perfectly elastic AS: Spare capacity means firms can increase output at constant average costs, as unemployed labour and unused capital are available.

    Phase 2 – Upward-sloping AS: As spare capacity decreases, factors of production become scarcer, increasing production costs and the price level as output rises.

    Phase 3 – Perfectly inelastic AS: At full capacity, all factors of production are employed, so output cannot increase further unless the quantity or productivity of resources improves. This corresponds to the New Classical LRAS.


<ul><li><p>Phase 1 – Perfectly elastic AS: Spare capacity means firms can increase output at constant average costs, as unemployed labour and unused capital are available.</p><p>Phase 2 – Upward-sloping AS: As spare capacity decreases, factors of production become scarcer, increasing production costs and the price level as output rises.</p><p>Phase 3 – Perfectly inelastic AS: At full capacity, all factors of production are employed, so output cannot increase further unless the quantity or productivity of resources improves. This corresponds to the New Classical LRAS.</p></li></ul><p></p>
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New classical LRAS curve

  • New Classical economists (including monetarists, supply-side and Austrian economists) believe in free markets and minimal government intervention.

  • LRAS is vertical at full-employment output (\(Y_f\)), representing the economy’s potential output.

  • Potential output depends on the quantity and productivity of factors of production, not the price level.

  • Therefore, a rise in the price level (\(P_1\) to \(P_2\)) does not change real output.

  • Full employment does not mean zero unemployment; some frictional and structural unemployment can remain.


<ul><li><p>New Classical economists (including monetarists, supply-side and Austrian economists) believe in free markets and minimal government intervention.</p></li><li><p>LRAS is vertical at full-employment output (\(Y_f\)), representing the economy’s potential output.</p></li><li><p>Potential output depends on the quantity and productivity of factors of production, not the price level.</p></li><li><p>Therefore, a rise in the price level (\(P_1\) to \(P_2\)) does not change real output.</p></li><li><p>Full employment does not mean zero unemployment; some frictional and structural unemployment can remain.</p></li></ul><p></p>
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Explain the difference between the Keynesian AS and the new classical LRAS

The main difference is that Keynesian LRAS suggests output can increase when demand rises, even in the long run, whereas New Classical LRAS assumes the economy will return to its full employment level of output in the long run.

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Potential economic growth

Potential economic growth is an increase in an economy’s maximum sustainable level of output, caused by an increase in the quantity or quality (productivity) of its factors of production.

  • It shifts LRAS to the right, as the economy’s productive capacity increases.

  • Causes include improved technology, better education and training, increased investment in capital and a larger labour force.

  • It allows the economy to produce more goods and services without causing demand-pull inflation, provided AD does not exceed the new capacity.


<p>Potential economic growth is an increase in an economy’s maximum sustainable level of output, caused by an increase in the quantity or quality (productivity) of its factors of production.</p><ul><li><p>It shifts LRAS to the right, as the economy’s productive capacity increases.</p></li><li><p>Causes include improved technology, better education and training, increased investment in capital and a larger labour force.</p></li><li><p>It allows the economy to produce more goods and services without causing demand-pull inflation, provided AD does not exceed the new capacity.</p></li></ul><p></p>