Lecture Notes: Aggregate Supply

Introduction

• Aggregate Supply (AS) is a complex topic in economics.
• Keynesian and Classical economists have different interpretations.
• Neither interpretation is definitively right or wrong.
• Understanding why they differ is important.

Classical Interpretation

Short-Run Aggregate Supply (SRAS)

• Characteristics:
  • Upward sloping.
  • Determined by costs of production.
• Shifts in SRAS:
  • Increase in production costs: Shifts left.
  • Decrease in production costs: Shifts right.
  • Affected by macro-level changes:
    • Wages: Increase shifts left, decrease shifts right.
    • Raw materials/commodities: Price rise shifts left, fall shifts right.
    • Oil price: Rise shifts left, fall shifts right.
    • Business taxes (VAT): Increase shifts left, decrease shifts right.
    • Import prices: Affected by exchange rates (strong currency = cheaper imports).
• Supply-Side Shocks:
  • Quick changes in SRAS, either positive (right shift) or negative (left shift).

Long-Run Aggregate Supply (LRAS)

• Characteristics:
  • Vertical in Classical model.
  • Represents one level of output (YFE - Full Employment level).
• Shifts in LRAS:
  • Increase in quantity/quality of factors of production or productive efficiency shifts right.
  • Examples: Improved labor productivity, increased investment, infrastructure improvement, immigration.
  • Shifts left due to labor productivity decrease, capital depreciation, war, pandemics, etc.
• Factors Affecting LRAS:
  • Quantity and quality of capital, enterprise, land, and labor.
  • Improvements in infrastructure and competition.
  • New resource discoveries.

Keynesian Interpretation

Differences from Classical

• Dispute over SRAS and LRAS:
  • Keynesians reject separate short-run and long-run AS concepts.
• Shape of AS Curve:
  • Bendy due to levels of spare capacity.
• Production Levels Below YFE:
  • Can be a long-run equilibrium.
  • In deep recession, production increases without inflation due to excess capacity.

Inflation Pressure & Capacity

• As economy approaches YFE:
  • Scarcity of labor and capital raises wages and costs.
  • Leads to inflation.
  • Curve becomes vertical when all factors are fully utilized.

Conclusion

• Understanding AS in both models is crucial for economic analysis.
• Next steps include understanding macro equilibrium by combining AD and AS.