1. AS Macro Revision
Aggregate Supply
Spring 2014

2. We add new resources / links / articles every day
to our Economics blogs
Follow this link for the AS Macro Blog on Tutor2u
www.tutor2u.net/blog/index.php/economics/categories/C59

3. Introduction to Aggregate Supply (AS)
• Aggregate supply (AS) is the quantity of goods and
services that producers in an economy are willing and
able to supply at a given level of prices
• Short run aggregate supply (SRAS) is the relationship
between real GDP and the price level
• SRAS shows how much output the economy can
generate in the short-term at each price level
• A rise in the price level should stimulate an
expansion of supply
• When prices are falling, production may contract
• The main factor causing a shift in SRAS is the cost of
producing goods and services

4. The Short Run Aggregate Supply Curve (AS)
General
Price Level
A rise in the price level causes an
expansion of aggregate supply
AS
GPL2
The short run AS
curve is upward
sloping because
higher prices for
goods and services
make output more
profitable and
enable businesses
to expand their
production by hiring
less productive
labour and other
resources
GPL1
A fall in the price
level causes a
contraction of
aggregate supply
GPL3
Y3
Y1
Y2
Real GDP

5. Shifts in Short Run Aggregate Supply (AS)
Input costs
•
•
•
•
Wage costs per unit of output
Labour productivity (higher efficiency lowers unit costs)
Raw material and component prices
Interest rates, business rents, fuel, energy costs
Business taxes, subsidies and imported costs
•
•
•
•
VAT, environmental charges / employment taxes
Scale and size of government subsidies to certain industries
Business rates, costs of meeting business regulations
Cost of imported components (affected by the exchange rate +
fluctuations in world commodity prices)
Supply shocks
• E.g. A hurricane, a tsunami or the effects of drought, flooding or political
crisis which can have an effect on a country’s national output

6. Showing Shifts in Short Run Aggregate Supply
General
Price Level
A shift from AS1 to AS2
is an inward shift of
short run aggregate
supply
AS2
GPL1
AS1
AS3
A shift from AS1 to AS3
is an outward shift of
short run aggregate
supply
Y2
Y1
Y3
Real GDP

7. External Factors affecting Aggregate Supply (AS)
World oil and gas prices
• The UK is a net importer of oil – an input used in many different industries
Energy prices / costs
• The UK is also a net importer of energy source such as coal
Other mineral / metal prices
• E.g. Rubber, iron ore, rare earths (used in many electronic products)
Foodstuff prices
• E.g. International prices for fresh foods, coffee, wheat, cocoa, sugar
Import tariffs / quotas
• The UK is a member of the European Union which sets a common import
tariff on different goods and services coming into the EU Single Market

8. Explaining the non-linear SRAS curve
• When spare capacity is high then SRAS will be elastic
• A rise in AD can be met easily by increased output
• There is little threat of rising prices (inflation)
• The elasticity of SRAS curve falls as output increases
• The amount of spare capacity declines
• Possibility of diminishing returns in production
• Bottlenecks in supply of inputs and components
• Resource shortages as the economy approaches full
employment e.g. Skilled labour becomes more scarce
• When SRAS becomes perfectly inelastic the economy is at
full capacity (equivalent to being on the PPF boundary)
• Further increases in AD at this point are purely
inflationary in the short run with little extra output

9. The (Keynesian) Non-Linear Aggregate Supply Curve
General
Price Level
AS
An outward shift in AD
from AD1 to AD2 can
be met without an
increase in the price
level because short run
aggregate supply is
highly elastic
AD5
AD4
GPL1
AD3
AD2
AD1
Y2
Y1
Real GDP

10. The (Keynesian) Non-Linear Aggregate Supply Curve
General
Price Level
GPL5
AS
An outward shift in AD
from AD3 to AD4
causes a sharp rise in
the general price level
because AS is inelastic
(i.e. output is close to
full-capacity levels)
AD5
GPL4
AD4
AD3
AD1
Real GDP
AD2
Y3 Y4

11. Long-Run Aggregate Supply (LRAS)
In the long run, the ability of an economy to produce goods and
services to meet demand is based on the state of production
technology and the availability and quality of factor inputs.
General
Price Level
LAS1
General
Price Level
Yp is the
estimated
potential
level of real
national
output in
the long
run
Yp
Real GDP
LAS1
LAS2
An
outward
shift of
LRAS
shows a
rise in
productive
potential
Yp1 Yp2 Real GDP

12. Increasing LRAS – Productive Potential
• Changes in potential GDP are brought about by:
• Changes in labour supply available for production
(i.e. more people join the labour force)
• Changes in the stock of capital inputs – affected by
the level of gross capital investment
• Changes in efficiency of allocation of factor inputs
• Improvements in the quality of factor inputs /
productivity of inputs
• Advances in the state of technology
• An outward shift of LRAS signifies an increase in longrun potential output and employment
• A higher level of LRAS signifies real economic growth

13. Key Factors affecting Long-Run Aggregate Supply
Higher Productivity
of Labour and
Capital
I.e. a rise in output
per person
employed or
increased efficiency
of technology
Increased Labour
Market
Participation
Gains from
Innovation and
Enterprise
i.e. A growing
Labour Supply and
a rise in the number
of people in work
These are two key
factors that
determine
competitiveness
Capital Investment
Including capital
spending by
businesses, inward
investment from
overseas and Public
Sector
(Government)

14. Productivity
Productivity measures the efficiency of the production process
Factor
Inputs
(land,
labour and
capital)
Factor
Productivity
Output
(efficiency)
• In the long run, productivity is a major determinant of economic
growth and of inflation
• A fall in labour productivity leads to a rise in firms’ (unit) costs of
production (assuming that the level of wages remains the same)
• Higher productivity allows businesses to pay higher wages and
achieve increased profits at the same time

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