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Edexcel A Level Economics A Your notes

2.3 Aggregate Supply (AS)

Contents
Characteristics of Aggregate Supply
Short-Run Aggregate Supply
Long-Run Aggregate Supply

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Characteristics of Aggregate Supply

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The Aggregate Supply (AS) Curve
Aggregate supply is the total supply of goods/services produced within an economy at a specific
price level at a given time

A diagram showing the upward sloping short run aggregate supply (SRAS) curve for an economy

The SRAS curve is upward sloping due to two reasons

The aggregate supply is the combined supply of all individual supply curves in an economy which
are also upward sloping
As real output increases, firms have to spend more to increase production e.g. wage bills will
increase
Increased costs result in higher average prices

A movement along the SRAS curve

Whenever there is a change in the average price level (AP) in an economy, there is a movement along
the short run aggregate supply (SRAS) curve

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Your notes

A diagram showing an increase and decrease in the average price level (AP) which causes a movement
along the short run aggregate supply (SRAS) curve leading to a contraction/expansion (extension) of
SRAS

Diagram analysis
An increase in the AP (ceteris paribus) from AP1 → AP2 leads to a movement along the SRAS curve
from A → B
There is an expansion (extension) of real GDP from Y1 → Y2
A decrease in the AP (ceteris paribus) from AP1 → AP3 leads to a movement along the SRAS curve from
A→C
There is a contraction of real GDP (output) from Y1→Y3

A shift of the entire SRAS curve

Whenever there is a change in the conditions of supply in an economy (e.g. costs of production), there
is a shift of the entire SRAS curve

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Your notes

A diagram showing a shift in the entire short run aggregate supply (SRAS) curve due to a change in one
of the conditions of supply in an economy

Diagram analysis
A decrease in labour costs results in a shift right of the entire curve from SRAS1 → SRAS2
At every price level, output and real GDP have increased from Y1 → Y2
An increase in labour costs results in a shift left of the entire curve from SRAS1 → SRAS3
At every price level, output and real GDP have decreased from Y1 → Y3

The Relationship Between Short-run & Long-run AS

Short run aggregate supply (SRAS) is influenced by changes in the costs of production
Short run refers to the time period where at least one factor of production is fixed
Long run aggregate supply (LRAS) is influenced by a change in the productive capacity of the
economy
Productive capacity is changed by changes to the quantity or quality of the factors of production
When production capacity changes, it is equivalent to a shift inwards/outwards of the
production possibilities frontier (PPF)

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Long term economic growth requires the productive capacity to increase

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Short-Run Aggregate Supply

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Factors Influencing Short-run AS
There are multiple factors that can influence the short-run aggregate supply (SRAS). These include:
Changes in costs of raw materials and energy
Changes in exchange rates (E/R)
Changes in tax rates
A Table That Explains the Influences on Short-Run Aggregate Supply (SRAS)

Change in Condition Explanation Impact on SRAS

Increase in costs of raw As the price of input costs rise, fewer SRAS decreases
materials/energy goods/services can be produced with the same - shifts left
amount of money

Decrease in costs of raw As the price of input costs decrease, more SRAS increases -
materials/energy goods/services can be produced with the same shifts right
amount of money

Appreciation of E/R Producers often import raw materials SRAS increases -

Stronger currency = cheaper imports shifts right
Cheaper imports = decrease in input costs
Lower costs = more output

Depreciation of E/R Producers often import raw materials SRAS decreases

Weaker currency = more expensive imports - shifts left
More expensive imports = increase in input costs
Higher costs = less output

Decrease in tax rates Taxes represent an additional cost for firms SRAS increases -
Decreasing taxes = decrease in costs shifts right
Lower costs = more output

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Increase in tax rates Taxes represent an additional cost for firms SRAS decreases
Increasing taxes = increase in costs - shifts left
Your notes
Higher costs = less output

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Long-Run Aggregate Supply

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Keynesian Versus Classical Long-run AS
Long run aggregate supply (LRAS) is influenced by a change in the productive capacity of the
economy
Productive capacity is changed by changes to the quantity or quality of the factors of production
Economists have two opposing views on how LRAS works in an economy
The original view is called the classical view
The insights developed by John Maynard Keynes in 1936 are called the Keynesian view

The classical LRAS view

The classical view believes that the LRAS is perfectly inelastic (vertical) at a point of full employment
of all available resources
This point corresponds to the maximum possible output on a production possibilities frontier
(PPF)
The classical view believes that in the long- run, an economy will always return to this full employment
level of output
There may be short-run output gaps in the economy
During extreme periods of economic growth, there can be an inflationary gap that develops
In the long run this will self-correct and return to the long-run level of output, but at a higher
average price level
During slowdowns or recessions there can be a recessionary gap that develops
In the long-run this will self-correct and return to the long-run level of output, but at a lower
average price level

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Your notes

A diagram that shows the Classical View of long-run aggregate supply (LRAS) with a vertical aggregate
supply curve at the full employment level of output (YFE)

Diagram analysis
Using all available factors of production, the long-term output of this economy (LRAS) occurs at YFE
The economy is initially in equilibrium at the intersection of AD1 and LRAS (P1, YFE)
A slowdown reduces output from AD1→AD2 and creates a short term recessionary gap
This self corrects in the long term and returns the economy to the long-run equilibrium at the
intersection of AD2 and LRAS (P2, YFE)

The keynesian LRAS view

Keynes believed that the long-run aggregate supply curve (LRAS) was more L shaped
Supply is elastic at lower levels of output as there is a lot of spare production capacity in the
economy
Struggling firms will increase output without raising prices
Supply is perfectly inelastic (vertical) at a point of full employment (YFE) of all available resources
The closer the economy gets to this point the more price inflation will occur as firms compete
for scarce resources

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The Keynesian view believes that an economy will not always self-correct and return to the full
employment level of output (YFE)
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It can get stuck at an equilibrium well below the full employment level of output e.g. Great
Depression
The Keynesian view believes that there is role for the government to increase its expenditure so as to
shift aggregate demand and change the negative 'animal spirits' in the economy

A diagram that shows the Keynesian View of long-run aggregate supply (LRAS) with a vertical
aggregate supply curve at the full employment level of output (YFE) becoming more elastic at lower
levels of output

Diagram analysis
Using all available factors of production, the long-term output of this economy (LRAS) occurs at YFE
The economy is initially in equilibrium at the intersection of AD1 and LRAS (P1, YFE)
A slowdown reduces output from AD1→AD2 and creates a recessionary gap Y1-YFE
The economy may reach a point where average prices stop falling (P2), but output continues to
fall
This economy may not self-correct to YFE for years
The low output leads to high unemployment and low confidence in the economy

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This stops further investment and further reduces consumption

Keynes argued that this was where governments needed to intervene with significant expenditure
e.g. Roosevelt's New Deal; response to financial crisis of 2008 Your notes
Factors Influencing Long-run AS
Any factor that changes the quantity or quality of a factor of production will impact the long-run
aggregate supply (LRAS) of an economy:
This corresponds to an outward or inward shift of the potential output of an economy on the
production possibilities frontier
The following factors will shift the entire LRAS curve outwards and increase the potential output of the
economy:
1. Technological advances: these often improve the quality of the factors of production e.g.
development of metal alloys
2. Changes in relative productivity: process innovation often results in productivity improvement e.g.
moving from labour intensive car production to automated car production
3. Changes in education and skills: over time this increases the quality of labour in an economy
4. Changes in government regulations: these can improve the quantity of the factors of production.
e.g. deregulation of fracking (extracting oil from shale deposits) increased oil reserves
5. Demographic changes and migration: a positive net birth rate or positive net migration rate will
increase the quantity of labour available
6. Competition policy: regulating industries so as to prevent monopoly power results in more firms
supplying goods/services in an economy and this increases the potential output of an economy

Examiner Tips and Tricks

You will frequently be examined on your understanding of factors that shift the short-run aggregate
supply (SRAS) curve and long-run aggregate supply (LRAS) curve.
Make sure you know the difference and remember that LRAS factors will shift the entire LRAS curve
to the right, representing an increase in the potential output of the economy. Changes to SRAS do
not change the potential output of the economy.
This is the impact a long-run shift will have:

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A diagram illustrating long-run economic growth through a change in one of the factors that shift
the long-run aggregate supply (LRAS) of the economy

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