hi everybody let's in this video cover aggregate supply by the end we'll be able to put aggregate supply and aggregate demand together to get macro equilibrium the next video in this playlist covers that topic area unfortunately aggregate supply is quite a heavy and complex topic area because it's heavily disputed in the economics World you've got Keynesian economists with their own interpretation of aggregate supply you've got classical economists with their own interpretation of aggregate supply neither School is right neither school is wrong so it's totally up to you to use whichever aggregate supply interpretation you want to use it's not going to be wrong use whatever you're comfortable with but what you need to know is why they differ and what aggregate supply looks like in both the different models here let's get straight into the classical interpretation in the classical model you can have short run aggregate supply and long run aggregate supply short-term aggregate supply looks like this upward sloping the position of shorter and aggregate supply is determined by costs of production in the economy if costs of production change the short run aggregate supply will shift if there is an increase in cost of production SRS will shift to the left if there is a decrease in cost of production SRS will shift to the right now we're talking about costs of production that can affect all firms in the economy so we're not just talking on a micro level this is clearly a macro level what costs of production can change that will affect all firms in the economy well wages for example if wages throughout the economy go up then that is going to increase cost of production for firms in the economy SRS will ship to the left from srs1 to srs3 here if wages decrease that's going to reduce cost of production for firms in the economy shifting SRS to the right if raw material or commodity prices go up then costs a production will rise of firms in the economy shifting SRS to the left if they fall then SRS will shift to the right because there is a decrease in cost of production for firms in the economy oil is a major cost of production so it's it's okay for the UK economy for example to keep the oil prices as a separate cost to production Factor even though it should really fall into this category oil is such an important input for all firms in the UK economy whether it's for transportation of their goods whether it's to access Goods themselves whether it's an actual input in that actual production oil price is so important when the oil price goes up costs of production for all firms in the economy will increase their shifting SRS to the left whereas if the oil price decreases that will reduce cost of production shifting SRS to the right business taxes like vat clearly impact cost of production if vat goes up that will increase costs of production if EET goes down that will reduce cost of production for all firms in the economy shifting SRS whichever way don't forget import prices import prices is massive especially for firms in the UK economy that rely on Imports of raw materials of Commodities in order to produce and import prices can change when the exchange rate changes so when there is a strong exchange rate Imports are cheaper that means for firms who import raw materials who import Commodities they will see a big drop in their cost of production where SRS will shift to the right whereas when there is a weak exchange rate import prices become much more expensive so for firms who import raw materials and commodities their cost of production will increase shifting SRS to the left so it says spice them without remember these memory devices where spices for a strong exchange rate and would act is for a week exchange rate strong pound Imports cheap exports here so Imports cheap weak pound or wheat currency Imports deer so there's the link to import prices and there's the link to SRS and cost of production another good thing to keep in your mind yes costs of production a great way to simplify this but just think shocks when sris shifts there is a supply-side shock in the economy because this shift can happen very quickly these are all very quick potentially even overnight factors that can shift SRS so these are shocks to the economy they can be positive if SRS shifts to the right we have a falling cost of production a positive supply side shop there can also be negative when SRS shifts to the left and we see negative growth when we put ad on our diagram higher inflation too that's a negative supply side shop which can lead to a phenomenon called stagflation so learn them also as supply-side shocks they can quickly shock the economy on the supply side here what about the classical interpretation of nres well in the classical model lres is vertical to represent one level of output the economy will always produce at in the long run and that level of output is yfe let's define yfe now yfe is the Full Employment level of output and it represents the maximum level of output and economy can produce using all factors of production at sustainable levels now that end part is really important sustainable levels which means it is possible to deviate from that even to increase output Beyond yfe if we're using factors of production unsustainably so for example if we're using labor over time too much overtime work going on eventually a labor will burn out unsustainable production if we're using Capital over time right so Machinery is being used 24 7 eventually that Machinery will break down unsustainable production so yfe the maximum level of output an economy can produce using all factors of production at sustainable levels classical economists believe that it's only one level of output which is why the long-run aggregate supply curve is vertical because according to classical economies we are always going to be there in the long run this one level of output lres reflects that output position when the economy is at their natural rate of unemployment that's when we are at the Fun employment level of output so that's how we can measure whether we are here or not in the UK for example the natural rate of unemployment is 4.5 I know it's a bit disputed but many economists will agree it's a 4.5 unemployment when we are there then economists agree that we are fully employing all of our factors of production all of our resources in the economy therefore we must be at the Full Employment level of output how can this kind of shift left or right well let's take an lrs shift to the right really simplify this guys to avoid confusion many students will make lots of Errors when they're trying to explain why lras shifts to the right simplify it by using this memory device the quantity and the quality of our factors of production I say Q squared of cell quantity and quality of capital Enterprise land and labor if the quantity and or the quality of our factors of production are increasing and improving then at RAS can shift to the right also there might be an improvement in the productive efficiency of the economy so no change in our factors of production but there is an improvement in productive efficiency learn this as a fall in Long Run costs of production none of these long run costs of production are falling and that will remain the case for a long period of time thus the productive efficiency of the economy is improving so three ways in which lrs can shift to the right and increasing the quantity of our factors of production and increasing the quality of our factors of production and in Improvement in the productive efficiency of the economy there okay if that happens NRS will shift to the right from lras1 to lrs2 and potentially the economy can produce more from y31 to yfv2 what factors could cause that so for example labor productivity improving that will increase the quality of Labor they're shifting nras to the right it could be an increase in investment throughout the economy remember what investment is guys it's when firms spend money on capital goods a big tip for you in your essays is to always give examples of investment whenever you talk about it so it could be for example technology advances research and development spending new Factory development it could be new machines being bought in it could be machine upgrades new software it could be a fleet of new vehicles being bought whatever just make sure you give examples which is clearly when firms are spending money on capital goods now clearly that's going to increase the quantity of capital it could increase the quality of capital and over time it could improve the productive efficiency of the economy as long run costs of production for firms decrease that's lrs can shift for all three ways there infrastructure improvements are so important let's take transport infrastructure so for example Building New Roads upgrading roads building new airports new runways new railway lines Bridges transport infrastructure will reduce long-run costs for all businesses in the economy because it means that transporting goods and services becomes quicker becomes cheaper becomes more efficient therefore the long-run costs of production for firms decrease improving the productive efficiency of the economy shifting lrs to the right another way to look at infrastructure improvements for example new I know pipe infrastructure maybe it's electricity pylons maybe it is transport infrastructure you can argue that the quantity and quality of a Capital stock in the economy improves thus shifting NRS to the right as well even if it's new schools new hospitals being built that's an increase in the quantity of capital you can shift lrs to the right as a result so infrastructure we can go to productive efficiency with transport infrastructure we can go to the quantity of stock and the quality of the Capital stock as well to shift lrs to the right we can look at increases in the quantity of Labor so maybe this is immigration so migrants coming into the country of a working age will increase the size of the labor force when we say Quantity of Labor it's the size of the labor force that we're talking about not the unemployed becoming employed because the unemployed are also part of the labor force it's increasing the size of the labor force right so migrants coming in of a working age maybe it's incentives like reducing benefits like cutting income tax for example where the inactive become active increasing the quantity of Labor we can look at competition competition is massive for productive efficiency improvements so maybe it's privatization maybe it's deregulation maybe it's trade liberalization maybe it's competition policy generally if competition improves throughout the economy then firms are going to be looking to reduce their cost as much as possible to stay competitive to beat their Rivals and that is going to increase productive efficiency throughout the economy and shift lras to the right we can also look at new resource discoveries and this comes under the land category we find new resources that's the quantity of land increasing they're shifting NRS to the right what about lrs shifting to the left in the economy well that could happen if there is a big decrease in labor productivity in the economy it can happen if there is mass Capital depreciation which shifts lras to the left it could be War conflict a natural disaster which destroys infrastructure which reduces the quantity of capital it could be these three things which leads to to death which reduces the quantity of Labor it could be a pandemic so a Health crisis in the economy which severe affects the productivity of Labor if that causes death that can decrease the quantity of Labor it could be hysteresis remember the hysteresis is a phenomenon caused by long-term unemployment where eventually workers become discouraged and they drop out the labor force reducing the quantity of Labor it could be emigration from the economy so when labor of a working age the workers of a working age actually leave the economy and that reduces the quantity of Labor so all of these factors can shift lras to the left what about the Keynesian interpretation then keynesians do not dispute at all the reasons why the lrs curve can shift to the right and to the left so all the factors we've talked about keynesians 100 agree with so shifting right increasing potential output shifting left decreasing potential output absolutely fine no disagreement there the disagreement occurs over the shape of lers and what NRS actually represents so Keynesian economies totally dispute the idea of there being a short-run aggregate supply and the long run aggregate supply they say that's totally useless there is a point where we reach for employment where the curve becomes vertical they believe but they say that look you know the economy can be producing less than yfe and that could be a long run level of output there isn't just one long run level of output that the economy will always be at no way if the economy is producing below yfe that could be a long run equilibrium in the economy they also heavily dispute the shape right and they say that the shape is bendy looking like this due to the level of spare capacity in the economy so for example they say that if the economy is in deep recession where output is way below full employment they say that it's possible to increase production without there being any increase in inflationary pressure at all and that is because there is mass unemployment of factors of production unemployment of Labor unemployment of capital unemployment of land so to increase production from here to Here For example it's very easy for firms to use up the excess labor to use up the excess Capital without having to pay more for them so wages for example will not rise capital for example the price of it will not rise which means that the inflation rate will remain constant at times of deep recession when we increase production on the horizontal part of Keynesian at RAS however the closer we get to yfe the more that we are using up our spec opacity the more pressure is being put on our existing factors of production so now labor is becoming scarcer so to employ labor wages will have to rise capital is becoming scarcer so to employ Capital firms will have to pay more for that Capital that will increase their cost of production they're going to pass that on Via higher prices in the economy and that will increase the inflation rate eventually to a point where we are fully utilizing all of our factors of production and it's not possible to increase output sustainably anymore there will only be an increase in inflation that's when the Keynesian aggregate supply curve becomes vertical but crucially they believe that we are not always at yfe at all we could be below Ife and that could be a long run equilibrium in the economy so that covers aggregate supply in detail hopefully now you get it the next video we're going to look at macro equilibrium when we put ad and as together stay tuned for that I'll see you all in that video