1. Aggregate Supply the total volume of goods and services produced within the economy at a given price level Price Level AS there is a positive relationship between AS and price level rising prices signal to businesses to expand production to meet higher AD as firms try to expand production, they need to increase prices in order to cover higher costs (eg. overtime workers)  AD → expansion of AS AS is determined by performance on the supply side of the economy; it reflects productive capacity and costs of production. GDP

2. Shifts in Aggregate Supply AS shifts from changes in production costs (labour, raw materials, taxes, subsidies Price Level AS AS 1 Real GDP This  AS could have been caused by: -  wage costs -  raw material costs -  taxes -  productivity -  subsidies to firms.

3. AD & AS A shift in one curve causes a movement along the other curve The same economic event may cause both curves to shift (you need to know which one is the primary shift and which is secondary) Price Level AD AD 1 Real GDP AS P P1P1 Y Y1Y1 Price Level AD Real GDP AS 1 P P1P1 Y1Y1 Y AS

4. Long Run Aggregate Supply indicates the maximum potential output possible with given resources and technology, and is independent of the price level (similar to the PPF) a theoretical ideal – not likely to be achievable, but we try to get as close as possible! shifts outward with improvements in productivity & efficiency – shifts inward with decreases in the same

5. Classical LRAS Price Level GDP LRAS LRAS 1 An increase in long- term potential of the whole economy (doesn’t necessarily mean we will actually grow!) A similar concept to the PPF…

6. Classical LRAS and Unemployment Real Output Price Level YfYf LRAS SRAS AD Y SRAS 1 P In the long run we assume the prices of factors of production (eg wages) are flexible, so since there is unemployment, there will be downward pressure on wages. This means firms costs will fall, which means SRAS shifts down, and we reach a long run equilibrium with full employment

7. Classical LRAS & SRAS Price Level AD AD 1 GDP SRAS LRAS SRAS 1 If AD increases such that the equilibrium is beyond LRAS (beyond max-capacity), firms will have to pay overtime, machines will break from overuse, etc – all of which will increase costs and reduce SRAS back to the LRAS equilibrium, but at a higher price level.

8. Keynsian LRAS If the classical view was correct, unemployment should only be temporary Yet we have had periods of mass unemployment (1930s depression; Greece & Spain today) John Maynard Keynes wrote on why this unemployment persisted in his book, ‘The General Theory of Employment, Interest and Money’ in 1936 There are several reasons he believed unemployment can persist, but we look for the moment at just one: Wages are ‘sticky’, ie they do not fall – or do not fall sufficiently This may be because of laws such as minimum wages, or legal protection, or because firms do not want to demotivate their workers This means SRAS will not shift down, and the short run equilibrium is in effect long run as well

9. Keynsian LRAS Price Level GDP LRAS Mass unemployment Keynsians think that unemployment may persist because wages don’t actually drop. So, when there is mass unemployment, output can increase or decrease without having an impact on price level. Full employment

10. Shifts in AD with Keynsian LRAS Price Level GDP LRAS AD to AD1 – because of mass unemployment, firms can expand output without putting up prices (lots of extra workers to hire at low wages) AD2 to AD3 – workers are starting to become more scarce so any increase in output will require paying slightly higher wages, increasing prices a bit AD4 to AD5 – the economy is at full capacity. Any increase in AD will only lead to increased prices and no extra output. AD 2 AD 3 AD 4 AD 5 AD AD 1