Aggregate Supply Lecture Notes

Overview

• Topic: Aggregate Supply
• Goal: Understand different interpretations of aggregate supply by Keynesian and Classical economists.
• Next topic: Macro equilibrium combining aggregate supply and demand.

Key Interpretations of Aggregate Supply

Classical Interpretation

• Short Run Aggregate Supply (SRAS)

  • Upward sloping curve.
  • Determined by costs of production.
  • Factors Affecting SRAS:
    • Wages: Increase shifts SRAS left; decrease shifts SRAS right.
    • Raw material/commodity prices: Increase shifts SRAS left; decrease shifts right.
    • Oil prices: Major cost factor; increase shifts SRAS left, decrease shifts right.
    • Business taxes (e.g., VAT): Increase shifts SRAS left; decrease shifts right.
    • Import prices: Affected by exchange rates.
      • Strong currency: Cheaper imports, SRAS shifts right.
      • Weak currency: Expensive imports, SRAS shifts left.
  • Supply-Side Shocks: Quick shifts in SRAS due to cost changes.
    • Positive shock: SRAS right shift
    • Negative shock: SRAS left shift

• Long Run Aggregate Supply (LRAS)

  • Vertical curve representing full employment output (YFE).
  • YFE: Full Employment level of output using sustainable factors of production.
  • Shifts in LRAS:
    • Right shift: Increase in quantity/quality of factors (Q² - Quality and Quantity of Capital, Enterprise, Land, Labor).
    • Productive Efficiency: Falling long-run costs improve efficiency.
    • Infrastructure improvements: Reducing long-run costs or improving capital stock.
    • Labor productivity improvements, investment, and competition increase LRAS.
    • Left shift: Decrease in productivity, capital depreciation, disasters, emigration.

Keynesian Interpretation

• Disagreement with Classical model on shape and role of LRAS.
• One Aggregate Supply Curve: No separate SRAS and LRAS.
• Shape of Curve:
  • Bendy due to spare capacity.
  • Horizontal segment: Increased production without inflation (mass factor unemployment).
  • Vertical segment: Full factor utilization, increased costs, and inflation.
  • Long-run equilibrium can occur below YFE.

Conclusion

• Classical and Keynesian models provide different perspectives on aggregate supply.
• Understanding both helps in analyzing economic situations.
• Upcoming topic: Macro equilibrium with combined aggregate supply and demand.