Lecture on Aggregate Supply

Introduction

• Aggregate supply and aggregate demand will be combined to determine macro equilibrium in future content.
• Aggregate supply is a complex topic with differing interpretations between Keynesian and Classical economists.
• No interpretation is definitively correct or incorrect; choose what is comfortable.

Classical Interpretation

Short-Run Aggregate Supply (SRAS)

• Characteristics: Upward sloping curve.
• Changes:
  • Determined by costs of production.
  • Increase in production costs shifts SRAS left; decrease shifts it right.
• Factors Influencing SRAS:
  • Wages, raw materials, oil, business taxes, import prices.
  • Exchange rates impact import prices; a strong currency makes imports cheaper.
• Supply-Side Shocks:
  • Positive shock: SRAS shifts right, indicating decreased costs.
  • Negative shock: SRAS shifts left, indicating increased costs.

Long-Run Aggregate Supply (LRAS)

• Characteristics: Vertical curve representing a single level of output (Y_FE) the economy can sustain long-term.

• Full Employment Level of Output (Y_FE):

  • Economy at natural rate of unemployment utilizes all resources sustainably.
  • UK's natural unemployment: ~4.5%.

• Shifts in LRAS:

  • Rightward shifts indicate improved quantity/quality of capital, labor, enterprise, and land.
  • Increased productive efficiency means reduced long-run production costs.

Factors Causing LRAS Shift

• Rightward Shifts:

  • Improved labor productivity.
  • Increased investment in capital goods.
  • Infrastructure improvements.
  • Immigration increasing labor force.
  • Enhanced competition and resource discoveries.

• Leftward Shifts:

  • Decrease in labor productivity.
  • Capital depreciation or destruction (war, disaster).
  • Health crises or long-term unemployment (hysteresis).
  • Emigration reduces labor force.

Keynesian Interpretation

• Disputes:

  • Rejects separate short-run and long-run supply curves.
  • Believes in multiple long-run output levels, not just Y_FE.

• Shape of LRAS:

  • Bendy curve due to spare capacity.
  • In deep recession, output can increase without inflation due to surplus resources.
  • As output nears Y_FE, scarcity increases costs, leading to inflation.
  • Vertical supply curve at full utilization of resources.

Conclusion

• Understanding aggregate supply is crucial for grasping macroeconomic equilibrium.
• Next content will involve combining aggregate demand and supply concepts.