Lecture on Aggregate Supply

Introduction

• The lecture focuses on aggregate supply and prepares us to combine it with aggregate demand for macroeconomic equilibrium.
• Aggregate supply is a complex and heavily debated topic in economics.
• Different interpretations by Keynesian and Classical economists.
  • Neither school is entirely right or wrong.
  • Choose the interpretation that suits your understanding.

Classical Interpretation of Aggregate Supply

Short-Run Aggregate Supply (SRAS)

• SRAS is upward sloping.
• Determined by costs of production across the economy.
• Shifts in SRAS:
  • Increase in costs (e.g., higher wages, commodity prices) shifts SRAS left.
  • Decrease in costs (e.g., lower wages, commodity prices) shifts SRAS right.
• Influential factors:
  • Wages: Increase shifts left; decrease shifts right.
  • Raw Materials: Price increases shift left; decreases shift right.
  • Oil Prices: Significant impact, treated separately in UK context.
  • Business Taxes: VAT changes affect production costs.
  • Import Prices: Affected by exchange rates.
    • Strong currency makes imports cheaper, shifting SRAS right.
    • Weak currency makes imports expensive, shifting SRAS left.

Supply-Side Shocks

• Quick shifts in SRAS, termed as shocks.
  • Positive shocks: Rightward shifts due to decreasing costs.
  • Negative shocks: Leftward shifts lead to stagflation (high inflation, stagnant growth).

Long-Run Aggregate Supply (LRAS)

• LRAS is vertical, reflects full employment (YFE) output.
  • YFE: Maximum sustainable output using all factors of production.
  • Deviations are possible with unsustainable use (e.g., overtime labor).
• Shifts in LRAS:
  • Rightward shifts: Increase in quantity/quality of production factors or improved productive efficiency.
    • Labor productivity improvements, increased investment, infrastructure development.
  • Leftward shifts: Decrease in labor productivity, capital depreciation, disasters, pandemics, and labor force reductions.

Keynesian Interpretation of Aggregate Supply

Disagreements With Classical View

• Keynesians agree with the factors affecting LRAS shifts but dispute the LRAS shape.
• They focus on aggregate supply without distinguishing between short and long run.
• The economy can have multiple long-run outputs below YFE.

Keynesian Aggregate Supply Curve

• Bendy shape due to variable spare capacity:
  • Deep Recession: Horizontal segment, increases in output without inflation.
  • Approaching YFE: Rising inflation due to scarcity of production factors.
  • At YFE: Vertical segment, output increases only lead to inflation.
• Long-run equilibrium can exist below YFE.

Conclusion

• The lecture explored classical and Keynesian interpretations of aggregate supply.
• Next, we will cover macroeconomic equilibrium by combining aggregate demand and aggregate supply.
• Stay tuned for the next video in the series.