4 The macroeconomy

The Macroeconomy (AS Level)

Candidates will explore national income as a crucial metric of macroeconomic performance and analyze its determination using the circular flow of income and Aggregate Demand/Aggregate Supply (AD/AS) models. Key concepts include equilibrium, disequilibrium, and time. They will examine the measurement, causes, and consequences of economic growth, unemployment, and price stability, using concepts such as progress and development, and equilibrium and disequilibrium.

4.1 National Income Statistics

4.1.1 Meaning of National Income

• National income is the total value of all goods and services produced within a country over a specific period, usually a year.
• It includes incomes earned by residents from domestic and foreign sources.

4.1.2 Measurement of National Income

• Three approaches to calculate GDP:

Gross Domestic Product (GDP)

• Definition: GDP is the total monetary value of all goods and services produced within a country's borders over a specific period, typically a year or a quarter. It measures economic activity within the country, regardless of whether the income is earned by nationals or foreign entities.

• Formula:

  • Expenditure Approach: GDP = C + I + G + (X - M)
    • C = Consumption (spending by households)
    • I = Investment (spending on capital goods)
    • G = Government spending
    • X = Exports
    • M = Imports
  • Income Approach: GDP = W + I + R + P + T
    • W = Wages
    • I = Interest
    • R = Rent
    • P = Profits
    • T = Taxes minus subsidies
  • Production Approach:
    GDP = Total\ Output - Intermediate\ Consumption

• Example: If a country produces 5 trillion worth of goods and services, households spend 3 trillion, firms invest 1 trillion, government spends 0.8 trillion, and exports are 0.5 trillion while imports are 0.3 trillion, the GDP using the expenditure approach would be:
  GDP = 3 + 1 + 0.8 + (0.5 - 0.3) = 5

Gross National Income (GNI)

• Definition: GNI is the total income earned by a country's residents, both domestically and internationally, over a specific period. It includes GDP plus net income from abroad (i.e., income earned by residents from investments and labor abroad, minus income earned by foreign nationals in the country).
• Formula:
  GNI = GDP + Net\ income\ from\ abroad
• Example: If a country has a GDP of 5 trillion and its net income from abroad is 0.2 trillion (i.e., residents earn 0.3 trillion abroad, and foreign nationals earn 0.1 trillion in the country), then the GNI would be:
  GNI = 5 + 0.2 = 5.2

Net National Income (NNI)

• Definition: NNI is the total income of a country's residents after accounting for depreciation (the wear and tear on the country's capital goods). It shows the income available to a country’s residents for consumption and savings after maintaining its capital stock.
• Formula: NNI = GNI - Depreciation
  • Where depreciation represents the loss in value of physical assets like buildings and machinery over time.
• Example: If the GNI is 5.2 trillion, and depreciation of capital is estimated at 0.3 trillion, the NNI would be:
  NNI = 5.2 - 0.3 = 4.9\ trillion

4.1.3 Adjustment of Measures from Market Prices to Basic Prices

• To adjust national income measures (such as GDP, GNI, and NNI) from market prices to basic prices, it is important to understand the difference between these two price concepts and how to apply the necessary adjustments.
  • Market Prices: These are the actual prices paid by consumers, including taxes (such as sales tax or VAT) and excluding subsidies on products.
  • Basic Prices: Basic prices refer to the amount received by producers, excluding taxes on products but including subsidies. They represent the true value of goods and services from the producers' point of view.
• The difference between market prices and basic prices lies in taxes on products and subsidies on products. Therefore, to adjust from market prices to basic prices, we need to subtract taxes on products and add subsidies on products.
• Formula for Adjustment:
  • To convert from market prices to basic prices: Measure\ at\ Basic\ Prices = Measure\ at\ Market\ Prices - Taxes\ on\ Products + Subsidies\ on\ Products
    • Taxes on Products include taxes such as VAT, excise duties, etc., imposed on the sale of goods and services.
    • Subsidies on Products include payments made by the government to reduce the cost of producing or selling goods and services.
• Example:
  • GDP at Market Prices: 5 trillion
  • Taxes on Products: 0.3 trillion
  • Subsidies on Products: 0.1 trillion
  • To calculate GDP at Basic Prices:
    GDP\ at\ Basic\ Prices = 5 - 0.3 + 0.1 = 4.8\ trillion
• Adjustment for GNI and NNI: The same formula applies when adjusting Gross National Income (GNI) and Net National Income (NNI) from market prices to basic prices.
  • GNI at Basic Prices:
    GNI\ at\ Basic\ Prices = GNI\ at\ Market\ Prices - Taxes\ on\ Products + Subsidies\ on\ Products
  • NNI at Basic Prices:
    NNI\ at\ Basic\ Prices = NNI\ at\ Market\ Prices - Taxes\ on\ Products + Subsidies\ on\ Products
• Why Adjust to Basic Prices?
  • Market prices reflect the costs borne by consumers, including taxes, but do not necessarily represent the revenue producers receive.
  • Basic prices provide a clearer picture of the value of production from the producer’s perspective, isolating it from government intervention (taxes and subsidies).

4.1.4 Adjustment of Measures from Gross Values to Net Values

• Adjusting national income measures from gross values to net values involves accounting for depreciation (also called capital consumption).


• Depreciation refers to the wear and tear or reduction in the value of capital assets (such as machinery, buildings, and equipment) over time. The net value excludes this depreciation, while the gross value includes it.


• Key Concepts:

• Gross Values: Gross values include the total value of production or income without deducting the depreciation of capital assets. Examples include Gross Domestic Product (GDP) and Gross National Income (GNI).
• Net Values: Net values represent the value after deducting depreciation, showing what is left after maintaining the capital stock. Examples include Net Domestic Product (NDP) and Net National Income (NNI).

• Where depreciation is the estimated value of capital assets that have worn out or become obsolete over the period.

• From Gross Domestic Product (GDP) to Net Domestic Product (NDP): NDP = GDP - Depreciation
  • Gross Domestic Product (GDP) represents the total value of all goods and services produced within a country.
  • Net Domestic Product (NDP) adjusts for the value lost due to depreciation, showing the net output after maintaining capital.
  • Example: If a country’s GDP is 5 trillion and the depreciation of capital is 0.3 trillion, the NDP would be:
    NDP = 5 - 0.3 = 4.7\ trillion
• From Gross National Income (GNI) to Net National Income (NNI): NNI = GNI - Depreciation
  • Gross National Income (GNI) represents the total income earned by a country’s residents, including income from abroad.
  • Net National Income (NNI) reflects the income after accounting for depreciation of the country’s capital.
  • Example:
    NNI = 5.2 - 0.3 = 4.9\ trillion
• From Gross Fixed Capital Formation (GFCF) to Net Fixed Capital Formation (NFCF): NFCF = GFCF - Depreciation
  • Gross Fixed Capital Formation (GFCF) refers to the value of investment in physical assets such as machinery, buildings, and infrastructure.
  • Net Fixed Capital Formation (NFCF) adjusts for depreciation, showing how much new capital stock is added after maintaining existing assets.

• Gross values are useful for understanding the total scale of economic activity, but they can overstate the actual growth and productivity because they do not account for the cost of replacing or maintaining capital stock.
• Net values give a more accurate picture of the economy’s sustainable output or income, showing how much is left for consumption, saving, and investment after maintaining the capital base.

4.2.1 Circular Flow of Income in a Closed Economy and an Open Economy: The Flow of Income Between Households, Firms, and Government and the International Economy

Circular Flow of Income in a Closed Economy

• A closed economy assumes no interactions with foreign economies (no imports, exports, or capital flows). The primary players are households, firms, and the government.
  1. Households:
     • Households own factors of production (land, labor, capital, and entrepreneurship) and supply them to firms in return for income (wages, rent, interest, and profits).
     • Households use their income to consume goods and services produced by firms, save money, or pay taxes.
  2. Firms:
     • Firms hire factors of production from households and use them to produce goods and services.
     • Revenue from selling goods and services goes to firms, which is used to pay for factors of production, invest in capital, or pay taxes.
  3. Government:
     • The government collects taxes from households and firms.
     • Taxes are spent on public goods and services (e.g., infrastructure, education, healthcare) and transfer payments (e.g., unemployment benefits).
• Flows in a Closed Economy:
  • Real Flow: Factors of production flow from households to firms, and goods/services flow from firms to households.
  • Monetary Flow: Wages, rent, interest, and profits flow from firms to households, while consumption expenditure flows from households to firms. Taxes flow to the government, and government spending flows back to households and firms.

Circular Flow of Income in an Open Economy

• An open economy includes international trade (exports and imports), foreign investments, and capital flows. The model expands to incorporate the foreign sector.
  1. Households:
     • Households still supply factors of production and consume goods/services, but they can also purchase imported goods/services.
     • Households might also save in foreign financial markets or invest abroad.
  2. Firms:
     • Firms sell goods and services to both domestic and international markets (exports) and purchase imports for production.
     • Revenue comes from domestic sales and exports.
  3. Government:
     • Governments interact with international economies through borrowing, lending, trade policies, and tariffs.
     • They also spend on foreign goods and services, such as military equipment or raw materials.
  4. Foreign Sector:
     • The foreign sector interacts with the domestic economy through imports, exports, and capital flows (e.g., foreign investments, remittances, and foreign aid).
     • Exports bring income into the domestic economy, while imports represent an outflow of money.
• Flows in an Open Economy:
  • Real Flow: In addition to goods/services and factors of production flowing domestically, goods and services are exchanged internationally.
  • Monetary Flow: Domestic income is augmented by export earnings and reduced by import expenditures. Capital also flows in and out of the domestic economy through foreign investments, loans, and other financial transactions.
• Comparison: Closed vs. Open Economy

• Diagram of Circular Flow in Both Economies
  1. Closed Economy: The circular flow includes only households, firms, and government.
     • Households → Firms: Factors of production.
     • Firms → Households: Wages, rent, goods, and services.
     • Government interacts with both through taxation and expenditure.
  2. Open Economy: The circular flow expands to include the foreign sector.
     • Exports flow from domestic firms to foreign markets.
     • Imports flow from foreign firms to domestic markets.
     • Foreign investments and capital flows are additional monetary flows.

4.2.2 Injections and Leakages (Multiplier Not Required)

Injections

• Injections are additions of income into the circular flow that increase economic activity. They represent spending that is not derived from households’ current income. The main components of injections are:
  1. Investment (I): Spending by firms on capital goods such as machinery, buildings, and equipment. This also includes spending on inventories of goods.
  2. Government Spending (G): Expenditure by the government on goods and services, such as infrastructure, education, and healthcare. Transfer payments (e.g., pensions or unemployment benefits) are not counted directly as injections but contribute indirectly when recipients spend this income.
  3. Exports (X): Spending by foreign buyers on domestic goods and services. This brings money into the domestic economy and boosts production.
• Summary of Injections:
  • Investment (I)
  • Government spending (G)
  • Exports (X)

Leakages

• Leakages are withdrawals of income from the circular flow, reducing the level of economic activity. They represent income not spent on domestic goods and services. The main components of leakages are:
  1. Savings (S): Income not spent by households but saved for future use, often deposited in banks or financial institutions.
  2. Taxes (T): Money paid to the government by households and firms, which reduces the disposable income available for consumption or investment.
  3. Imports (M): Spending by households, firms, or the government on goods and services produced abroad, which removes money from the domestic economy.
• Summary of Leakages:
  • Savings (S)
  • Taxes (T)
  • Imports (M)

Balancing Injections and Leakages

• If injections > leakages, the economy expands, as more money is being added than withdrawn. This leads to increased production, income, and employment.
• If leakages > injections, the economy contracts, as more money is withdrawn than added. This reduces demand, output, and employment.
• When injections = leakages, the economy is in equilibrium, with no change in the level of economic activity.
• Key Points
  • Injections stimulate the economy by increasing spending and production.
  • Leakages reduce the economy's flow of income by diverting money away from consumption and investment in the domestic market.
  • Understanding injections and leakages is essential for analyzing economic growth and stability.
• Examples of Injections:
  1. Investment (I):
     • A company purchases machinery to increase production.
     • A real estate developer builds new apartments.
  2. Government Spending (G):
     • Construction of highways and bridges.
     • Funding public schools or hospitals.
  3. Exports (X):
     • A domestic car manufacturer sells vehicles to overseas markets.
     • A software company provides services to international clients.
• Examples of Leakages:
  1. Savings (S):
     • A household deposits part of its income in a bank savings account.
     • Firms retain profits instead of reinvesting them.
  2. Taxes (T):
     • Households pay income tax to the government.
     • Firms pay corporate taxes on their profits.
  3. Imports (M):
     • A consumer buys a smartphone manufactured abroad.
     • A retailer imports clothing from another country.

4.2.3 Equilibrium and Disequilibrium (Marginal and Average Propensities Not Required)

Equilibrium in the Circular Flow of Income

• Equilibrium occurs when the total injections into the circular flow of income are equal to the total leakages. In this state, there is no tendency for the level of income, output, or economic activity to change.
• Condition for Equilibrium:
  (I + G + X) = (S + T + M)
• Implications of Equilibrium:
  1. The economy is stable, with no unplanned changes in production or inventory levels.
  2. Aggregate demand (total spending) is equal to aggregate supply (total production).
  3. Businesses experience no pressure to expand or reduce output because their inventories remain constant.

Disequilibrium in the Circular Flow of Income

• Disequilibrium occurs when injections are not equal to leakages. This results in changes to the overall level of economic activity.
• Types of Disequilibrium:
  1. Injections > Leakages:
     • When injections exceed leakages, the economy experiences expansion.
     • There is increased demand for goods and services, leading to higher production, income, and employment levels.
     • Example: If government spending (G) or investment (I) increases significantly while savings (S) or taxes (T) remain constant, the economy may grow rapidly.
  2. Leakages > Injections:
     • When leakages exceed injections, the economy contracts.
     • Demand for goods and services falls, leading to lower production, income, and employment levels.
     • Example: If households save more (S) or imports (M) rise significantly without a corresponding increase in exports (X), businesses may cut back on production.
• Key Differences between Equilibrium and Disequilibrium

• Examples:
  1. Equilibrium:
     • A country with balanced government spending and taxation (G = T), stable exports and imports (X = M), and steady savings and investment (S = I) is in equilibrium.
  2. Disequilibrium:
     • If a country reduces taxes (T) without increasing government spending (G), this creates a mismatch where injections exceed leakages, causing economic growth but potentially leading to inflation.
     • On the other hand, if imports (M) rise significantly without a matching increase in exports (X), this reduces demand for domestic goods, leading to economic contraction.
• Keynesian 45 degree approach
• Saving and investment
  • A rise in savings also causes GDP to fall. In fact a decision by households to save more can actually result in them saving less, because higher saving reduces income and hence the ability of households to save, known as the paradox of thrift.
• Inflationary and Deflationary Gaps
  • An economy may not achieve full employment in the short run (Keynesians would argue nor in the long run). If aggregate expenditure exceeds the potential output of the economy, then there is an inflationary gap. In this case not all demand can be met, due to insufficient resources. So excess demand pushes the price level up.
  • If the equilibrium level of GDP is below the full employment level, then there is a deflationary gap, as shown below, where the lack of aggregate expenditure results in an equilibrium level Y of GDP, below the full employment level of X. The deflationary gap is vw. The Keynesian solution to a deflationary gap is to increase government spending by borrowing

4.3 Aggregate Demand and Aggregate Supply Analysis

4.3.1 Definition of Aggregate Demand (AD)

• Aggregate Demand (AD) refers to the total quantity of goods and services demanded in an economy at a given overall price level and within a specific time period. It represents the total expenditure on an economy's goods and services by households, firms, the government, and foreign buyers.

4.3.2 Components of AD and Their Meanings:

AD = C + I + G + (X – M)

• Formula for Aggregate Demand: AD = C + I + G + (X - M)$$
  • Where:
    • C = Consumption: Spending by households on goods and services (e.g., food, clothing, and housing).
    • I = Investment: Spending by firms on capital goods (e.g., machinery, equipment) and inventory.
    • G = Government Spending: Expenditure on public goods and services (e.g., infrastructure, education).
    • X = Exports: Spending on domestically produced goods and services by foreign buyers.
    • M = Imports: Spending on foreign-produced goods and services by domestic buyers (subtracted as it does not contribute to domestic demand).

4.3.3 Determinants of AD (Detailed Knowledge of the Components of AD is Not Required)

• The determinants of Aggregate Demand (AD) are the factors that influence the total demand for goods and services in an economy. These determinants cause shifts in the Aggregate Demand curve, either increasing or decreasing overall demand at all price levels.
• Below are the key determinants:
  1. Consumer Spending (C)
     • Consumer spending is the largest component of AD and is influenced by:
       • Disposable Income: Higher income leads to more consumption, increasing AD.
       • Interest Rates: Lower interest rates make borrowing cheaper and encourage spending, while higher rates reduce spending.
       • Consumer Confidence: Optimism about future income and employment encourages spending, whereas pessimism reduces it.
       • Wealth: An increase in household wealth (e.g., rising property or stock prices) boosts spending, while a decrease reduces it.
  2. Investment Spending (I)
     • Investment refers to spending by businesses on capital goods and is affected by:
       • Interest Rates: Lower interest rates reduce the cost of borrowing, encouraging investment. Higher rates discourage investment.
       • Business Confidence: Firms invest more when they expect economic growth and profitability.
       • Technological Changes: Innovations often prompt increased investment in new equipment and infrastructure.
       • Government Policies: Tax incentives or subsidies for businesses can encourage investment.
  3. Government Spending (G)
     • Government spending on public goods and services (e.g., infrastructure, defense, education) directly impacts AD. It is influenced by:
       • Fiscal Policy: Expansionary fiscal policy (increased spending or reduced taxes) raises AD, while contractionary fiscal policy (reduced spending or higher taxes) lowers AD.
       • Economic Priorities: Governments may increase spending during recessions to boost demand or reduce spending during periods of inflation.
  4. Net Exports (X - M)
     • Net exports are the difference between exports (X) and imports (M) and are influenced by:
       • Exchange Rates: A depreciation of the domestic currency makes exports cheaper and imports more expensive, increasing net exports and AD. An appreciation has the opposite effect.
       • Global Demand: Strong demand from trading partners boosts exports, while weaker demand reduces them.
       • Trade Policies: Tariffs, quotas, and trade agreements can impact export and import levels.
       • Relative Prices: If domestic goods are cheaper compared to foreign goods, exports rise and imports fall, boosting AD.
• Other General Factors Affecting AD
  • Population Growth: A growing population increases consumption and demand for goods and services.
  • Inflation Expectations: If people expect future price rises, they may spend more now, increasing AD.
  • Economic Shocks: Events like pandemics, wars, or natural disasters can sharply affect components of AD, either boosting or reducing demand.
• Summary
  • The key determinants of AD include changes in:
    1. Consumer Spending (C): Affected by income, confidence, interest rates.
    2. Investment Spending (I): Driven by business confidence, interest rates, and policies.
    3. Government Spending (G): Influenced by fiscal policy and economic priorities.
    4. Net Exports (X - M): Affected by exchange rates, global demand, and trade policies.
• When these factors change, the Aggregate Demand curve shifts:
  • Rightward Shift: When determinants increase AD (e.g., higher government spending or lower interest rates).
  • Leftward Shift: When determinants decrease AD (e.g., higher taxes or reduced consumer confidence).

4.3.4 Shape of the AD Curve (Downward Sloping)

• Key Points to Remember:
  • The rectangular hyperbola shape is a more accurate representation of the AD curve, especially in the short run.
  • The slope of the AD curve can vary depending on the strength of the real balance effect and other factors.
  • In reality, the AD curve may not be perfectly hyperbolic, but it can be approximated by this shape under certain conditions.

4.3.5 Causes of a Shift in the AD Curve

• Causes of a Leftward Shift in the AD Curve (Decrease in AD)
  • A decrease in AD indicates lower total spending in the economy. The curve shifts to the left due to the following factors:
    1. Decrease in Consumer Spending (C):
       • Lower Disposable Income: Caused by wage reductions or tax hikes.
       • Falling Consumer Confidence: Households become pessimistic about future economic conditions.
       • Wealth Effect: Declining asset values (e.g., falling house prices) reduce spending.
       • Higher Interest Rates: Borrowing becomes more expensive, discouraging spending.
    2. Decrease in Investment (I):
       • Higher Interest Rates: Increases the cost of borrowing, discouraging business investment.
       • Falling Business Confidence: Firms expect lower profits or economic stagnation.
       • Uncertainty: Political or economic instability reduces the willingness to invest.
    3. Decrease in Government Spending (G):
       • Contractionary Fiscal Policy: Government reduces spending to control debt or inflation.
       • Cuts to Public Programs: Reduction in spending on infrastructure, education, or healthcare.
    4. Decrease in Net Exports (X - M):
       • Stronger Domestic Currency: An appreciation of the currency makes exports more expensive and imports cheaper, reducing net exports.
       • Weak Global Demand: Economic slowdown in trading partner countries decreases demand for domestic exports.
       • Trade Restrictions: New tariffs or quotas imposed on domestic exports reduce foreign sales.
• Summary of Shifts

4.3.6 Definition of Aggregate Supply (AS)

• Aggregate Supply (AS) refers to the total quantity of goods and services that producers in an economy are willing and able to supply at a given overall price level in a specific time period. It represents the production side of the economy and shows the relationship between the price level and the total output supplied.
• Key Characteristics of Aggregate Supply
  1. Short-Run Aggregate Supply (SRAS):
     • In the short run, aggregate supply is influenced by production costs such as wages, raw material prices, and energy costs.
     • The SRAS curve slopes upward, indicating that as prices rise, firms are willing to produce more because higher prices increase profitability.
  2. Long-Run Aggregate Supply (LRAS):
     • In the long run, aggregate supply is determined by the productive capacity of the economy (e.g., labor, capital, technology).
     • The LRAS curve is vertical, reflecting the idea that in the long run, output is determined by the economy's resources and efficiency, not by the price level.

4.3.7 Determinants of AS

• The Aggregate Supply (AS) curve represents the total supply of goods and services that producers are willing to supply in the economy at various price levels. The determinants of AS influence the ability of firms to produce goods and services. These factors can be divided into short-run determinants and long-run determinants.
  1. Short-Run Determinants of Aggregate Supply (SRAS)
     • In the short run, the AS curve slopes upward, reflecting that as the price level rises, firms are incentivized to increase production, assuming other factors (like wages) remain constant. The key determinants in the short run include:
     • a. Changes in Resource Prices:
       • Example: If the price of oil increases, firms face higher production costs, which can reduce the quantity of goods and services supplied at any given price level, causing a leftward shift in the SRAS curve.
       • Effect: Higher resource prices, such as wages or raw materials, lead to a decrease in AS, as production becomes more costly.
     • b. Changes in Productivity:
       • Example: If a new technology improves the efficiency of workers, firms can produce more output with the same amount of inputs. This leads to an increase in AS, shifting the SRAS curve to the right.
       • Effect: Improvements in productivity, like automation or better management techniques, lower the cost of production and increase the supply of goods and services.
     • c. Supply Shocks:
       • Example: A natural disaster, such as a hurricane, can disrupt the supply of key inputs like energy or raw materials, reducing production capacity in the economy.
       • Effect: Negative supply shocks (e.g., natural disasters or geopolitical instability) reduce AS, shifting the SRAS curve leftward, while positive supply shocks (e.g., an abundance of a key resource) increase AS.
     • d. Changes in Taxes or Subsidies:
       • Example: If the government introduces a tax on production or reduces subsidies for certain industries, production becomes more expensive, leading to a decrease in AS.
       • Effect: Higher taxes on businesses or reduced subsidies lead to a leftward shift in the SRAS curve, while tax cuts or subsidies for firms boost AS.
  2. Long-Run Determinants of Aggregate Supply (LRAS)
     • In the long run, the economy’s output is determined by the availability of factors of production, such as labor, capital, and technology. The LRAS curve is vertical, reflecting that in the long run, output is determined by the productive capacity of the economy, regardless of the price level.
     • a. Changes in the Quantity or Quality of Labor:
       • Example: An increase in the labor force (due to immigration or higher birth rates) can increase the economy’s productive capacity. Similarly, improvements in education and training can raise the quality of labor.
       • Effect: A larger or more skilled workforce increases potential output, shifting the LRAS curve to the right.
     • b. Investment in Physical Capital:
       • Example: If firms invest in new machinery, equipment, and infrastructure, the economy’s ability to produce goods and services increases.
       • Effect: Increased investment in capital goods boosts the productive capacity of the economy, shifting the LRAS curve to the right.
     • c. Technological Progress:
       • Example: Breakthroughs in technology (e.g., the internet, automation, renewable energy) can lead to more efficient production processes, allowing for higher output with the same level of input.
       • Effect: Technological improvements increase productivity, shifting the LRAS curve to the right as the economy can produce more goods and services at full employment.
     • d. Institutional and Policy Changes:
       • Example: If the government reduces regulations or provides incentives for innovation, firms are more likely to increase their production capacity.
       • Effect: Policies that improve efficiency or the business environment (e.g., deregulation, reducing trade barriers) can increase AS by enhancing the economy’s potential output.
• Summary Table: Determinants of Aggregate Supply

4.3.8 Shape of the AS Curve in the Short Run (SRAS, Upward Sloping Line or Sweeping Curve) and the Long Run (LRAS, Either a Vertical Line or in Three Sections – Highly Elastic, Upward Sloping, Vertical)

4.3.9 Causes of a Shift in the AS Curve in the Short Run (SRAS) and in the Long