hi everybody let's in this video cover

aggregate supply by the end we'll be

able to put aggregate supply and
aggregate demand together to get macro
equilibrium the next video in this
playlist covers that topic area
unfortunately aggregate supply is quite
a heavy and complex topic area because
it's heavily disputed in the economics
World you've got Keynesian economists
with their own interpretation of
aggregate supply you've got classical
economists with their own interpretation
of aggregate supply neither School is
right neither school is wrong so it's
totally up to you to use whichever
aggregate supply interpretation you want
to use it's not going to be wrong use
whatever you're comfortable with but
what you need to know is why they differ
and what aggregate supply looks like in
both the different models here let's get
straight into the classical
interpretation in the classical model
you can have short run aggregate supply
and long run aggregate supply short-term

Short term aggregate supply

aggregate supply looks like this upward
sloping the position of shorter and
aggregate supply is determined by costs
of production in the economy if costs of
production change the short run
aggregate supply will shift if there is
an increase in cost of production SRS
will shift to the left if there is a
decrease in cost of production SRS will
shift to the right now we're talking
about costs of production that can
affect all firms in the economy so we're
not just talking on a micro level this
is clearly a macro level what costs of
production can change that will affect
all firms in the economy well wages for
example if wages throughout the economy
go up then that is going to increase
cost of production for firms in the
economy SRS will ship to the left from
srs1 to srs3 here
if wages decrease that's going to reduce
cost of production for firms in the
economy shifting SRS to the right if raw
material or commodity prices go up then
costs a production will rise of firms in
the economy shifting SRS to the left if
they fall then SRS will shift to the
right because there is a decrease in
cost of production for firms in the
economy oil is a major cost of
production so it's it's okay for the UK
economy for example to keep the oil
prices as a separate cost to production
Factor even though it should really fall
into this category oil is such an
important input for all firms in the UK
economy whether it's for transportation
of their goods whether it's to access
Goods themselves whether it's an actual
input in that actual production oil
price is so important when the oil price
goes up costs of production for all
firms in the economy will increase their
shifting SRS to the left whereas if the
oil price decreases that will reduce
cost of production shifting SRS to the
right business taxes like vat clearly
impact cost of production if vat goes up
that will increase costs of production
if EET goes down that will reduce cost
of production for all firms in the
economy shifting SRS whichever way
don't forget import prices import prices
is massive especially for firms in the
UK economy that rely on Imports of raw
materials of Commodities in order to
produce and import prices can change
when the exchange rate changes so when
there is a strong exchange rate Imports
are cheaper that means for firms who
import raw materials who import
Commodities they will see a big drop in
their cost of production where SRS will
shift to the right whereas when there is
a weak exchange rate import prices
become much more expensive so for firms
who import raw materials and commodities
their cost of production will increase
shifting SRS to the left so it says
spice them without remember these memory
devices where spices for a strong
exchange rate and would act is for a
week exchange rate strong pound Imports
cheap exports here so Imports cheap weak
pound or wheat currency Imports deer so
there's the link to import prices and
there's the link to SRS and cost of
production

Supplyside shocks
another good thing to keep in your mind
yes costs of production a great way to
simplify this but just think shocks when
sris shifts there is a supply-side shock
in the economy because this shift can
happen very quickly these are all very
quick potentially even overnight factors
that can shift SRS so these are shocks
to the economy they can be positive if
SRS shifts to the right we have a
falling cost of production a positive
supply side shop there can also be
negative when SRS shifts to the left and
we see negative growth when we put ad on
our diagram higher inflation too that's
a negative supply side shop which can
lead to a phenomenon called stagflation
so learn them also as supply-side shocks
they can quickly shock the economy on
the supply side here what about the
classical interpretation of nres
well in the classical model lres is
vertical to represent one level of
output the economy will always produce
at in the long run and that level of
output is yfe let's define yfe now yfe
is the Full Employment level of output
and it represents the maximum level of
output and economy can produce using all
factors of production at sustainable
levels now that end part is really
important sustainable levels which means
it is possible to deviate from that even
to increase output Beyond yfe if we're
using factors of production
unsustainably so for example if we're
using labor over time too much overtime
work going on eventually a labor will
burn out unsustainable production if
we're using Capital over time right so
Machinery is being used 24 7 eventually
that Machinery will break down
unsustainable production so yfe the
maximum level of output an economy can
produce using all factors of production
at sustainable levels
classical economists believe that it's
only one level of output which is why
the long-run aggregate supply curve is
vertical because according to classical
economies we are always going to be
there in the long run this one level of
output lres reflects that output
position
when the economy is at their natural
rate of unemployment that's when we are
at the Fun employment level of output so
that's how we can measure whether we are
here or not in the UK for example the
natural rate of unemployment is 4.5 I
know it's a bit disputed but many
economists will agree it's a 4.5
unemployment when we are there then
economists agree that we are fully
employing all of our factors of
production all of our resources in the
economy therefore we must be at the Full
Employment level of output
how can this kind of shift left or right
well let's take an lrs shift to the
right really simplify this guys to avoid
confusion many students will make lots
of Errors when they're trying to explain
why lras shifts to the right simplify it
by using this memory device the quantity
and the quality of our factors of
production I say Q squared of cell
quantity and quality of capital
Enterprise land and labor if the
quantity and or the quality of our
factors of production are increasing and
improving then at RAS can shift to the
right also there might be an improvement
in the productive efficiency of the
economy so no change in our factors of
production but there is an improvement
in productive efficiency learn this as a
fall in Long Run costs of production
none of these long run costs of
production are falling and that will
remain the case for a long period of
time thus the productive efficiency of
the economy is improving so three ways
in which lrs can shift to the right and
increasing the quantity of our factors
of production and increasing the quality
of our factors of production and in
Improvement in the productive efficiency
of the economy there

How LRAS can shift

okay if that happens NRS will shift to
the right from lras1 to lrs2 and
potentially the economy can produce more
from y31 to yfv2 what factors could
cause that so for example labor
productivity improving that will
increase the quality of Labor they're
shifting nras to the right it could be
an increase in investment throughout the
economy remember what investment is guys
it's when firms spend money on capital
goods a big tip for you in your essays
is to always give examples of investment
whenever you talk about it so it could
be for example technology advances
research and development spending new
Factory development it could be new
machines being bought in it could be
machine upgrades new software it could
be a fleet of new vehicles being bought
whatever just make sure you give
examples which is clearly when firms are
spending money on capital goods now
clearly that's going to increase the
quantity of capital it could increase
the quality of capital and over time it
could improve the productive efficiency
of the economy as long run costs of
production for firms decrease that's lrs
can shift for all three ways there
infrastructure improvements are so
important let's take transport
infrastructure so for example Building
New Roads upgrading roads building new
airports new runways new railway lines
Bridges transport infrastructure will
reduce long-run costs for all businesses
in the economy because it means that
transporting goods and services becomes
quicker becomes cheaper becomes more
efficient therefore the long-run costs
of production for firms decrease
improving the productive efficiency of
the economy shifting lrs to the right
another way to look at infrastructure
improvements for example new I know pipe
infrastructure maybe it's electricity
pylons maybe it is transport
infrastructure you can argue that the
quantity and quality of a Capital stock
in the economy improves thus shifting
NRS to the right as well even if it's
new schools new hospitals being built
that's an increase in the quantity of
capital you can shift lrs to the right
as a result so infrastructure we can go
to productive efficiency with transport
infrastructure we can go to the quantity
of stock and the quality of the Capital
stock as well to shift lrs to the right
we can look at increases in the quantity
of Labor so maybe this is immigration so
migrants coming into the country of a
working age will increase the size of
the labor force when we say Quantity of
Labor it's the size of the labor force
that we're talking about not the
unemployed becoming employed because the
unemployed are also part of the labor
force it's increasing the size of the
labor force right so migrants coming in
of a working age maybe it's incentives
like reducing benefits like cutting
income tax for example where the
inactive become active increasing the
quantity of Labor
we can look at competition competition
is massive for productive efficiency
improvements so maybe it's privatization
maybe it's deregulation maybe it's trade
liberalization maybe it's competition
policy generally if competition improves
throughout the economy then firms are
going to be looking to reduce their cost
as much as possible to stay competitive
to beat their Rivals and that is going
to increase productive efficiency
throughout the economy and shift lras to
the right we can also look at new
resource discoveries and this comes
under the land category we find new
resources that's the quantity of land
increasing they're shifting NRS to the
right what about lrs shifting to the
left in the economy well that could
happen if there is a big decrease in
labor productivity in the economy it can
happen if there is mass Capital
depreciation which shifts lras to the
left it could be War conflict a natural
disaster which destroys infrastructure
which reduces the quantity of capital it
could be these three things which leads
to to death which reduces the quantity
of Labor it could be a pandemic so a
Health crisis in the economy which
severe affects the productivity of Labor
if that causes death that can decrease
the quantity of Labor it could be
hysteresis remember the hysteresis is a
phenomenon caused by long-term
unemployment where eventually workers
become discouraged and they drop out the
labor force reducing the quantity of
Labor it could be emigration from the
economy so when labor of a working age
the workers of a working age actually
leave the economy and that reduces the
quantity of Labor so all of these
factors can shift lras to the left what
Keynes Interpretation
about the Keynesian interpretation then
keynesians do not dispute at all the
reasons why the lrs curve can shift to
the right and to the left so all the
factors we've talked about keynesians
100 agree with so shifting right
increasing potential output shifting
left decreasing potential output
absolutely fine no disagreement there
the disagreement occurs over the shape
of lers and what NRS actually represents
so Keynesian economies totally dispute
the idea of there being a short-run
aggregate supply and the long run
aggregate supply they say that's totally
useless
there is a point where we reach for
employment where the curve becomes
vertical they believe but they say that
look you know the economy can be
producing less than yfe and that could
be a long run level of output there
isn't just one long run level of output
that the economy will always be at no
way if the economy is producing below
yfe that could be a long run equilibrium
in the economy they also heavily dispute
the shape right and they say that the
shape is bendy looking like this due to
the level of spare capacity in the
economy so for example they say that if
the economy is in deep recession where
output is way below full employment
they say that it's possible to increase
production without there being any
increase in inflationary pressure at all
and that is because there is mass
unemployment of factors of production
unemployment of Labor unemployment of
capital unemployment of land so to
increase production from here to Here
For example it's very easy for firms to
use up the excess labor to use up the
excess Capital without having to pay
more for them so wages for example will
not rise capital for example the price
of it will not rise which means that the
inflation rate will remain constant at
times of deep recession when we increase
production on the horizontal part of
Keynesian at RAS
however the closer we get to yfe the
more that we are using up our spec
opacity the more pressure is being put
on our existing factors of production so
now labor is becoming scarcer so to
employ labor wages will have to rise
capital is becoming scarcer so to employ
Capital firms will have to pay more for
that Capital that will increase their
cost of production they're going to pass
that on Via higher prices in the economy
and that will increase the inflation
rate eventually to a point where we are
fully utilizing all of our factors of
production and it's not possible to
increase output sustainably anymore
there will only be an increase in
inflation that's when the Keynesian
aggregate supply curve becomes vertical
but crucially they believe that we are
not always at yfe at all we could be
below Ife and that could be a long run
equilibrium in the economy so that
covers aggregate supply in detail
hopefully now you get it the next video
we're going to look at macro equilibrium
when we put ad and as together stay
tuned for that I'll see you all in that
video

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