AS: 3.2.2 How the macroeconomy works 2.2.5 Determinants of short-run aggregate supply What are the 4 factors of production? How easy is it to increase the availability of each in the short-run? AS: 3.2.2 How the macroeconomy works

2.2.5 Determinants of short-run aggregate supply The price level and production costs are the main determinants of the short-run AS Changes in costs, such as: money wage rates, raw material prices, business taxation and productivity, will shift the short-run AS curve

Aggregate Supply: A Definition Questions What is the shape of a normal supply curve? Why is it upward sloping? What does ‘aggregate’ mean? “The total value of output of the economy at a given price level at a given point in time.”

The Short-Run Aggregate Supply Curve Building diagrams: Axis? AS Curve? Price Level Real National Output SRAS P Y

What is meant “Short-Run”? In economics, we differentiate between the short-run and long-run It is important not to think of this in terms of a specific time period, as the short and long run is more of a concept to be applied In the short-run it is assumed that all factors of production are fixed The only exception to this is that firms may be able to hire more labour, or make existing labour and other existing resources work harder, in order to meet aggregate demand

Movements Along the SRAS Curve A rise in the price level leads to an expansion in short-run aggregate supply . Changes in aggregate demand lead to movements along the SRAS curve e.g. if AD increases, firms will hire more labour and make resources work harder in order to boost supply as they see an opportunity to increase profits. Price Level SRAS P1 P P2 A fall in the price level leads to a contraction in short-run aggregate supply. Y2 Y Y1 Real National Output

Factors Affecting SRAS (1) Money wage rates do not take into account inflation. Real wages are money wages adapted for inflation. Short-run aggregate supply can shift when there is a change in the costs of production. These could be: Wages If wage rates increase, then firms may substitute labour for capital (assuming they are able to do so), or employ less labour to maintain profit margins The price of raw materials Higher raw material prices, e.g. oil, metals, increase the firms costs of production and will reduce SRAS Productivity The productivity of land, labour and capital can change in the short run. For example, a good harvest will increase output of foodstuff shifting SRAS to the right

Factors Affecting SRAS (2) Taxes and subsidies An increase in business tax rates e.g. Corporation tax will increase costs of production and SRAS will decrease An increase in business subsidies will lower costs of production and SRAS will increase Exchange rates and imports Many businesses will import raw materials or components for the production process If the currency strengthens, this makes purchasing those raw materials relatively cheaper and SRAS will increase

Shifts of the SRAS Curve An increase in costs of production will lead to a shift from SRAS to SRAS2. SRAS2 Price Level SRAS SRAS1 P A decrease in costs of production will lead to a shift from SRAS to SRAS1. Y2 Y Y1 Real National Output

Multiple Choice 1 SRAS1 Price Level SRAS2 Real National Output The shift of the short-run aggregate supply curve from SRAS1 to SRAS2 can be explained by a fall in the price level the world price of oil the trend rate of growth productivity Can you explain your answer? Price Level Real National Output SRAS1 SRAS2 B

Multiple Choice 2 The short-run aggregate supply curve is drawn on the assumption that investment in the economy is constant the prices of factors of production are constant the money supply is constant consumption expenditure by households is constant Can you explain your answer? B