THE DETERMINANTS OF SHORT-RUN AGGREGATE SUPPLY

1. Candidates should be able to define short-run aggregate supply and identify the determinants of the short-run AS curve, such as money wage rates, business taxation and productivity. THE DETERMINANTS OF SHORT-RUN AGGREGATE SUPPLY

2. Short run is the Period the time period when at least one factor of production is fixed in supply Price level – because we are now looking at the average price for all goods and services not just one product Price level SRAS This is the value of the output of all the goods and services produced in the given time period. The ‘real’ means the numbers are adjusted for inflation We could use Q for quantity here. Y stands for national income and because the value of output is the same as national income many texts use a Y P2 P1 Y1 Y2 Real national output

3. The AS (or SRAS) curve is the summation of all the individual supply curves of each firm which all slope upwards because, other things being equal, a higher price means higher profits and it is the profit motive, we assume, that motivates firms. Price level SRAS P2 P1 Y1 Y2 Real national output

4. SRAS 2 Price level SRAS 1 • A change in: • costs of raw materials, • money wages, • Productivity, • taxes on businesses, • moves the whole SRAS curve P1 Q1 Q2 Real national output

5. The extreme Keynesian AScurve AS In the 1930s Keynes was most worried about unemployment. He thought the macro economy did not work in the same way as markets did at a micro level. It was possible to have equilibrium in the goods and services market at a level of AD that was too low to achieve a level of national income where there was full employment (Yfe) Price level P1 Yfe Real national output

6. The extreme Keynesian AScurve AS Price level Keynesians saw AS as perfectly elastic. As AD increases, supply increases until Yfe is achieved (i.e. the economy is on the PPF). Any increase in AD beyond Yfe is inflationary as AS becomes perfectly inelastic. P3 Yfe is the full-employment level of national income P1 AD3 AD2 AD1 Y1 Real national output Y2 Yfe

7. The moderate Keynesian AScurve AS Price level As output increases spare capacity is reduced and ‘bottlenecks’ in production occur, output can still increase but the prices of the factors of production are bid up too. So AS gradually curves upwards Beyond Yfe the economy is on the PPF and an increase in AD just results in price increases. P3 P2 P1 AD2 AD1 AD3 Y1 Y2 Real national output Yfe

8. The moderate Keynesian AS curve AS Price level P3 P2 P1 AD3 AD2 AD1 Y1 Y2 Real national output Yfe

9. The moderate Keynesian AScurve LRAS Price level One way of thinking about a Keynesian AS curve is that it is perfectly elastic in the short run……… …..and perfectly inelastic in the long run. Labeling the curve LRAS is common. Real national output

10. LRAS Price level Real national output Yfe

11. LRAS Free market economists believe in “Say’s Law”, meaning “supply creates its own demand”. In the long run markets always achieve equilibrium and so AS is perfectly inelastic. Price level We might call these economists “SUPPLY SIDERS” Real national output Yfe

12. LRAS Free market economists believe in “Say’s Law”, meaning “supply creates its own demand”. In the long run markets always achieve equilibrium and so AS is perfectly inelastic. Price level Real national output Yfe

13. Any increase in AD merely leads to a higher price level. LRAS Price level P3 P2 P1 AD3 AD2 AD1 Real national output Yfe

14. LRAS Price level P3 P2 P1 AD3 AD2 AD1 Real national output Yfe

15. LRAS Price level P3 P2 P1 AD3 AD2 AD1 Real national output Yfe

16. SRAS A few new classical economists even used to say SRAS is vertical and because of rational expectations any increase in government spending immediately causes prices to rise. Price level P3 P2 This sometimes get changed to the “NATURAL RATE OF UNEMPLOYMENT” which is a monetarist idea P1 AD3 AD2 AD1 Real national output Yfe

17. Keynesian/free-market consensus A neo-classical/Keynesian consensus Price level SRAS Real national output

18. Keynesian/free-market consensus A neo-classical/Keynesian consensus LRAS Price level SRAS Real national output Yfe

19. 1. Show what will happen if the price of oil on world commodity markets falls, and fill in the missing labels. SRAS 1 SRAS 2 Price level P1 P2 AD Y1 Real national output Y2

20. Show what will happen if the price of oil on world commodity markets falls, and fill in the missing labels. Price level P1 P2 AD Y1 Real national output

21. Using a Monetarist/Free market LRAS curve show what will happen if the level of government spending increases.

22. Using a Monetarist/Free market LRAS curve show what will happen if the level of government spending increases. Price level Real national output

23. Using a Keynesian AS curve show what will happen if the economy is currently in a slump and the level of government spending increases. Price level Real national output

24. Actual GDP Short-run growth – percentage change in actual GDP Trend Growth Long-run growth – the productive potential of the economy increases (shown by the trend line)

25. HYSTERISIS occurs when a recession/depression leads to a loss of skills and deterioration in infrastructure and capital so that the productive potential is harmed and the rate of long-run growth is reduced Actual GDP Trend Growth

26. Short-run and long-run growth Price level Short-run growth – percentage change in actual GDP Long-run growth – the productive potential of the economy increases. PPF2 PPF1 Real National Income

27. Improving the productive potential (capacity) of the economy LRAS1 LRAS2 Price level Real National Income

28. Output gaps

29. Actual GDP A positive output gap occurs when actual GDP is greater than potential GDP. TrendGrowth = productive potential of the economy Positive output gap A negative output gap occurs when actual GDP is less than potential GDP. Negative output gap

30. LRAS Price level SRAS1 AD Real national output Y1 Yfe A negative output gap

31. LRAS Price level SRAS2 SRAS1 AD Real national output Y2 Yfe A positive output gap (unsustainable in the LR)

32. AS Macroeconomics Supply-side policies

33. Improving the productive potential (capacity) of the economy LRAS1 LRAS2 Price level Real National Income

34. Supply-side policies • Supply-side policies are policies that improve the productive potential / capacity of an economy. • Supply-side policies can be implemented by the public or the private sector.

35. Policies include: • Competition policy including privatisation/nationalisation. Deregulation and regulation. • Policies aimed at stimulating entrepreneurship and the expansion of smaller businesses • Labour market reforms including tax and benefit changes, migration policy • Trade policies including membership of the EU single market and WTO commitments • Policies designed to increase spending on investment and research

47. Supply-side objectives The key supply-side concepts to focus on are incentives, enterprise, technology, mobility, flexibility and efficiency. • Improve incentives to find work • Increase labour and capital productivity • Increase the occupational and geographical mobility of labour • Increase capital investment and R&D spending by firms • Promote competition and stimulate invention and innovation • Provide a platform for sustained non-inflationary growth of an economy

48. Lone Parent Benefit reform: In Oct 2008, lone parents had move onto JSA and look for work once their youngest child reached the age of 12 rather than 16. In Oct 2010, lone parents had to switch to Jobseekers Allowance (JSA) even earlier, to when their youngest child is seven Evaluation is it in the long-term interest of society’s well-being to encourage single mothers to leave their children so early on in their childhood? http://bcove.me/5l5u6fre

49. That’s all