Macroeconomics: Aggregate supply (Short run aggregate supply (SRAS): in…
Macroeconomics: Aggregate supply
Aggregate supply (AS):
Is the total productive capacity of the economy. It is the sum of all the individual supply curves for particular goods.
The AS curve shows maximum potential output; there is a strong correlation with a production possibility frontier (PPF) curve, which also shows the maximum potential of an economy.
Short run aggregate supply (SRAS)
: in the short run, AS is elastic. Higher prices encourage firms to supply more and increase capacity.
Factors that affect SRAS
The exchange rate.
A devaluation in the currency will increase the cost of many imported raw materials, such as oil and shift SRAS to the left.
Taxes and Subsidies.
A rise in VAT or excise duty will increase the cost of goods and shift SRAS to the left.
The price of raw materials
, E.g oil prices
A rise in wages will increase the cost of firms and shift SRAS to the left.
Effect of increase in the price of oil on SRAS:
An increase in the price of oil would shift SRAR to the left, this is known as a supply side shock.
Or a rise in the price of commodities, such as food or coffee
A supply-side shock could also occur as a result of rapid devaluation, causing a rise in the price of imported goods
Or a powerful trade unions causing a rapid rise in wages.
Long -run aggregate supply (LRAS): In the long run, AS is determined by the quantity of factors of production and the productivity of labour/capital
The long-run aggregate supply curve illustrates the normal capacity level of output in the economy. It may be referred to as 'full capacity' level output.
Factors that affect LRAS:
Education and skills: Improved education and vocational skills enable workers to be more productive and offer higher added value, increasing productive capacity
Infrastructure: Imporved transport links reduce the cost of transport and encourage trade; this is important for boosting productive capacity
Investment: If firms or the government invest in increasing the capital stock, we will see higher AS in the long term.
Government policies: the government can affect the LRAS by its supply-side policies on education, competitiveness and regulation.
Technology: Technological improvements are one of the biggest factors affecting labour productivity.
Attitudes to enterprise: A stable economic and political climate may encourage entrepreneurs to invest and develop businesses
Population: A rise in the number of working age people will increase the labour force and increase productivity capacity. The working age population can be affected by birth rates and net migration.
Financial system: A strong banking system that can allow firms to gain credit for investment will help increase productive capacity. A fragile banking system could damage LRAS.