Y1 10) Aggregate Supply - SRAS & LRAS (Classical and Keynes)

Summary

This video explains the concept of aggregate supply (AS) in economics, comparing the Classical and Keynesian models. The Classical view features upward-sloping short-run aggregate supply (SRAS) and a vertical long-run aggregate supply (LRAS) curve, with shifts influenced by factors like labor, capital, and productivity. In contrast, Keynesians believe the economy can operate below full employment and argue the SRAS is more flexible. They emphasize that during recessions, the economy can increase output without triggering inflation. The video provides insights into how supply-side shocks, changes in production costs, and shifts in labor and capital affect aggregate supply and macroeconomic equilibrium.

Takeaways

• 😀 Classical economists believe aggregate supply consists of short-run aggregate supply (SRAS) and long-run aggregate supply (LRAS), each affected by different factors.
• 😀 SRAS is upward sloping, and its position can shift based on production costs like wages, raw materials, oil prices, business taxes, and exchange rates.
• 😀 Changes in costs of production, such as higher wages or increased oil prices, shift SRAS to the left, while decreases in costs shift SRAS to the right.
• 😀 The long-run aggregate supply (LRAS) in the classical model is vertical, representing the economy's full employment level of output (Yfe), which is the sustainable maximum production level.
• 😀 The natural rate of unemployment, often around 4.5% in the UK, reflects when the economy is producing at Yfe and utilizing all factors of production sustainably.
• 😀 Shifts in LRAS can occur when there is an increase in the quantity or quality of factors of production (labor, capital, land, enterprise), or through improvements in productive efficiency.
• 😀 Improvements in infrastructure, such as transportation networks or new resource discoveries, can shift LRAS to the right by increasing the economy's productive capacity.
• 😀 Keynesians agree with the classical model's factors for shifting SRAS and LRAS but dispute the idea of a fixed long-run output level (Yfe) and the shape of the supply curve.
• 😀 The Keynesian view emphasizes that during deep recessions, the economy can produce below Yfe without increasing inflation, as there is unused capacity in labor and capital.
• 😀 As the economy nears full employment, inflationary pressures increase because resources like labor and capital become scarcer, driving up production costs and pushing inflation higher.
• 😀 In the Keynesian model, the AS curve starts as horizontal at low levels of output (reflecting spare capacity), becoming vertical only when full employment is reached.

Q & A

What is the significance of aggregate supply in macroeconomics?

Aggregate supply represents the total production of goods and services in an economy at different price levels, and it helps in determining macroeconomic equilibrium when combined with aggregate demand.

What are the two main schools of thought regarding aggregate supply?

The two main schools are Keynesian economics and classical economics, each having different interpretations of aggregate supply. Keynesians argue that economies can be below full employment, while classical economists believe the economy always produces at full employment in the long run.

How does short-run aggregate supply (SRAS) shift according to classical economics?

In classical economics, the short-run aggregate supply curve shifts based on changes in the cost of production, such as wages, raw materials, oil prices, and business taxes. An increase in these costs shifts SRAS to the left, while a decrease shifts it to the right.

What are some factors that can cause the SRAS to shift to the left?

Factors that can shift SRAS to the left include rising wages, higher oil prices, increased business taxes, and unfavorable exchange rates leading to higher import prices.

What does the classical interpretation say about long-run aggregate supply (LRAS)?

In the classical interpretation, LRAS is vertical, reflecting the economy's potential output at full employment. This output, denoted as Yfe, represents the maximum sustainable level of production using all factors of production at sustainable levels.

What factors can cause the LRAS to shift to the right?

LRAS can shift to the right if there is an increase in the quantity or quality of factors of production, such as improvements in labor productivity, investment in capital, infrastructure improvements, or better technology. Additionally, an increase in labor force size or an improvement in productive efficiency can also shift LRAS rightward.

What role does investment play in shifting LRAS?

Investment, such as spending on new machinery, technology, or infrastructure, increases both the quantity and quality of capital in the economy, which can improve productive efficiency and shift LRAS to the right.

How do Keynesians view the shape of the aggregate supply curve?

Keynesians argue that the aggregate supply curve is not vertical in the short run. They believe that the economy can operate below full employment, and the AS curve is upward sloping with a bend, reflecting the unused capacity and the gradual increase in production costs as the economy approaches full employment.

What happens when the economy operates on the horizontal part of the Keynesian AS curve?

When the economy operates on the horizontal part of the Keynesian AS curve, it is in a deep recession, where there is excess capacity (unemployed labor and capital). Increasing production does not lead to inflationary pressure because firms can utilize these unused resources without raising costs.

What is stagflation, and how can it be caused by shifts in SRAS?

Stagflation is a situation where the economy experiences both stagnation (negative growth) and inflation at the same time. It can occur when SRAS shifts to the left due to rising costs of production, leading to higher prices and lower output, which increases inflation and unemployment simultaneously.