15 Aggregate Supply

Relationship between APL and output

positive

Short run:

period of time when the prices of the FOP’s do not change

• price of labour fixed

If larger level of output

likely higher COP

Law of diminishing returns:

marginal and average costs rise as output rises in short run

what will shift SRAS curve

Change in COP

• Change in wage rates

  • Increase in wages, Increase COP, Fall in supply

• Change in cost of raw materials

  • Depends on change in price and how much its used

• change in price of imports

  • Rise in import prices, can increase COP

• Change in gov. indirect tax or subsidies

  • Increase indirect tax, COP increase

  • increase subsidies, increase supply

Macroeconomic equilibrium

AD meets SRAS

New classical LRAS

• Belief in efficiency of market forces, should be min. gov. intervention

• LRAS perfectly inelastic, full employment level of output

• LRAS independent of price level

  • price level can rise, output stays same

Keynesian AS

Phase 1) AS completely elastic

• producers can increase output at same price without increase costs because of spare capacity

  • high levels of unused factors

Phase 2) As economy approaches potential output, economy’s available factors become scarce

• have to bid for factors

• Higher prices, for COP, price level increase to compensate

Phase 3) AS perfectly inelastic, economy reaches full output capacity

• corresponds to LRAS in new classical

What will shift LRAS and AS curve?

Improvement in quality of FOP’s

increase productivity or increase in quantity of FOP’s