2.3 Aggregate Supply

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By the end of this unit you should be able to:
  • Describe the term aggregate supply.
  • Explain, using a diagram, why the short-run aggregate supply curve (SRAS curve) is upward sloping.
  • Explain, using a diagram, how the AS curve in the short run (SRAS) can shift due to factors including changes in resource prices, changes in business taxes and subsidies and supply shocks.
  • Explain, using a diagram, that the monetarist/new classical model of the long-run aggregate supply curve (LRAS) is vertical at the level of potential output (full employment output) because aggregate supply in the long run is independent of the price level.
  • Explain, using a diagram, that the Keynesian model of the aggregate supply curve has three sections because of “wage/price” downward inflexibility and different levels of spare capacity in the economy.
  • Explain, using the two models above, how factors leading to changes in the quantity and/or quality of factors of production (including improvements in efficiency, new technology, reductions in unemployment, and institutional changes) can shift the aggregate supply curve over the long term.​

Introduction to Aggregate Supply

 Classical LRAS vs Keynesian LRAS

Evaluating Supply Side Policies


Both are supply side policies that we looked at in unit 2.3 with the goal of increasing the long run output of the economy. If they work macroeconomic objectives can be met:
  1. Low unemployment
  2. Stable rate of inflation
  3. Economic growth
  4. Equity in the distribution of income (hopefully a rise in living standards but is this guaranteed?)

……. Improving the balance of payments

As you read through the following policies try to think of a (+) and a (-) for each and always try to have a diagram in your head.

Market-based supply-side policies
These focus on allowing markets to operate more freely, these policies usually involve incentives for people to buy more / be more productive or reduce business cost.
  1. Cutting government spending and borrowing
  2. Lower business taxes to stimulate investment and lower income taxes to improve work incentives
  3. Reducing red-tape to cut the costs of doing business
  4. Measures to improve the flexibility of the labour market / reforming employment laws
  5. Policies to boost competition such as deregulation and tough anti-monopoly and anti-cartel laws
  6. Privatisation of state assets (selling off public sector businesses into the private sector)
  7. Opening up an economy to overseas trade and investment (e.g. encouraging foreign direct investment or inward migration of workers)

Interventionist policies
The government plays a fundamental role in encouraging growth (e.g. government spending on education)
  1. State has key role in investing in public services and building critical infrastructure
  2. Tax incentives and welfare reforms can encourage more people into work
  3. A commitment to a fair minimum wage / living wage to improve work incentives
  4. Active regional policy to boost underperforming areas / areas of high unemployment
  5. Some case for selective import controls to allow domestic industries to expand
  6. Management of the exchange rate to improve competitiveness of export industries
  7. Nationalisation of some key industries
  8. Stronger regulation of industries
  9. Government support for women to become more educated
  10. Instituting a progressive tax system

Some of these policies will increase production and others productivity. It will really help you if you are able to identify which do what. E.G, “by increasing education spending workers of the futures will be more productive leading to a more efficient use of scarce resources and a shift in the LRAS to the right”

Discuss market oriented and interventionist policies that the government of _____________ might employ to achieve economic development.       

  • The golden rule here is that you must talk about the methods mentioned in the case study and then use information in the case study as well as your own knowledge to evaluate.
  • Answer the question - it states economic development (economic growth can help, but only if….?????????)
  • You can of course use outside information and should to demonstrate your depth of knowledge.
  • If you can compare offer real life examples from other countries around the world you will be hitting the highest mark-bands.
  • Diagram
  • And make a judgement at the end!!!!!!!!