Wednesday, 15 June 2011

Aggregate Supply (Macroeconomics)

So, what is aggregate supply?
Well, aggregate supply is the total output of goods and services that producers in an economy are willing and able to supply at different price levels in a given time period. Aggregate supply can be modeled on a diagram in two ways: the long run and the short run.

In this diagram we have a long run aggregate supply curve, sometimes shortened to just 'LRAS'. We can see that initially supply increases as the price level increases as businesses stand to make more profit. The curve then hits at vertical point. This point is know as full employment. What this means is that all factors of production are fully employed so there can be no more growing. So, after this point the only change that occurs is the increase in price levels. The point of full employment is similar to operating on the edge of the PPC which was described in a previous post. The next post will go into further detail about the long run diagrams. 

Another way aggregate supply can be modeled is in the short run. 

Here we have aggregate supply in the short run, sometimes referred to as just 'AS'. In this the curve is simply sloping upwards as factors of production ca easily be increased or improved in the short run. The AS may increase (shift to the right on the diagram) if there are falls in production costs or a fall in wages. It may decrease (shift to the left on the diagram) if production costs increase or something like the price of oil increase. 

Going back to the long run aggregate supply curve now. It has the potential to shift if aggregate supply changes. 

The causes of changes in the LRAS curve are:
  • A fall in interest rates. This will encourage businesses to invest therefore allowing them to expand and increase supply. This will shift LRAS to LRAS 1 on the diagram. If interest rates rose the opposite would happen and we could end up at curve LRAS 2 on the diagram.
  • Unemployment related benefits could be reduced. This would encourage more to try and get back into work, thus giving more potential labour for firms. This will increase LRAS to LRAS 1. The opposite would happen if unemployment related benefits were increased.
  • Education and training will improve the productivity of the workforce.. pushing LRAS out to LRAS 1. If funding for education and training was cut then LRAS may fall to curve LRAS 2.

That's pretty much it for a brief overview of aggregate supply. In the next post i'll be looking at aggregate supply and aggregate demand together and how these can be modeled on one diagram. Thanks for reading!

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