What is aggregate

supply?

AGGREGATE SUPPLY SIR BURUNGUDZI

 WHAT IS AGGREGATE SUPPLY?

Aggregate supply is the total output Long run aggregate supply

of goods and services that firms in represents a maximum output
an economy are willing and able to when all factors of production are
supply at a given price level fully and efficiently employed

AGGREGATE SUPPLY SIR BURUNGUDZI

 Aggregate Supply

Aggregate supply (AS) is the total

planned output of goods and
services that businesses within an
economy are willing and able to
supply (produce) at a given general
price level at a given time.
AGGREGATE SUPPLY SIR BURUNGUDZI
 Short Run Aggregate Supply

Short run aggregate supply (SRAS) is the

relationship between planned national output
(GDP) and the general price level (GPL).

AGGREGATE SUPPLY SIR BURUNGUDZI

 Short Run Aggregate Supply

Short run aggregate supply (SRAS) is the

relationship between planned national output
(GDP) and the general price level (GPL)

Important point: We assume that productivity

and costs of production and the state of
technology is constant in the short run when
drawing the SRAS.
AGGREGATE SUPPLY SIR BURUNGUDZI
 SHORT-RUN AGGREGATE SUPPLY CURVE
General Price
Level (GPL)

Real GDP (Y)

 SHORT-RUN AGGREGATE SUPPLY CURVE
General Price
Short Run
Level (GPL)
Aggregate
Supply

Real GDP (Y)

 SHORT-RUN AGGREGATE SUPPLY CURVE
General Price
Short Run
Level (GPL)
Aggregate
Supply

GPL1

Y1 Real GDP (Y)

SHORT-RUN AGGREGATE SUPPLY CURVE (EXPANSION)
General Price
Short Run
Level (GPL)
Aggregate
Supply
GPL2

GPL1

Y1 Y2 Real GDP (Y)

Rising demand and prices stimulates an expansion of supply
Producers are assumed to respond to the profit motive when market
demand is increasing, and the general price level is rising
 SHORT-RUN AGGREGATE SUPPLY CURVE (EXPANSION)
General Price
Short Run
Level (GPL)
Aggregate
Supply
GPL2
A rise in the general
price level usually GPL1
stimulates an
expansion of short-
run aggregate supply
as producers
respond to higher
demand and prices.

Y1 Y2 Real GDP (Y)

SHORT-RUN AGGREGATE SUPPLY CURVE (CONTRACTION)
General Price
Short Run
Level (GPL)
Aggregate
Supply
GPL2

GPL1

GPL3

Y3 Y1 Y2 Real GDP (Y)

 SHORT-RUN AGGREGATE SUPPLY CURVE (CONTRACTION)
General Price
Short Run
Level (GPL)
Aggregate
Supply
A fall in the general GPL2
price level usually
leads to a GPL1
contraction of short-
run aggregate supply GPL3
as producers cut
back production if
demand and prices
are falling.

Y3 Y1 Y2 Real GDP (Y)

Falling demand causes a contraction of supply
 SHORT-RUN AGGREGATE SUPPLY CURVE (CONTRACTION)
General Price
Short Run
Level (GPL)
Aggregate
Supply
A fall in the general GPL2
price level usually Assumption
leads to a GPL1 when drawing
contraction of short- the curve:
run aggregate supply We hold the state
GPL3
as producers cut of technology
and production
back production if
costs constant
demand and prices
are falling.

Y3 Y1 Y2 Real GDP (Y)

 UK CAR PRODUCTION (VEHICLES PER YEAR)
2,000,000

1,800,000 1722698

1,600,000
Car production volume in units

1,400,000

1,200,000

1,000,000
859575
800,000

600,000

400,000

200,000

0
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021
 INDEX OF OUTPUT OF PRIVATE HOUSE-BUILDING (2018=100)

120

100

80
Index numbers

60

40

20

0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
 SHIFTS IN SHORT-RUN AGGREGATE SUPPLY
General Price
Level (GPL)
SRAS1

The short run

aggregate supply GPL1
curve (SRAS1) will
shift when there is a
change in the supply
costs of firms
throughout the
economy

Y1 Real GDP (Y)

 INWARD SHIFT (FALL) IN SHORT-RUN AGGREGATE SUPPLY
General Price SRAS2
Level (GPL)
SRAS1

The short run

aggregate supply GPL1
curve (SRAS1) will
shift when there is a
change in the supply
costs of firms
throughout the
economy

Y2 Y1 Real GDP (Y)

 INWARD SHIFT (FALL) IN SHORT-RUN AGGREGATE SUPPLY
General Price SRAS2
Level (GPL)
SRAS1
An increase in costs
for firms throughout
the economy will GPL1
cause an inward
shift of SRAS from
SRAS1 to SRAS2.
Less can be
produced at each
general price level.

Y2 Y1 Real GDP (Y)

OUTWARD SHIFT IN SHORT-RUN AGGREGATE SUPPLY
General Price SRAS2
Level (GPL)
SRAS1
SRAS3
GPL1

Y2 Y1 Y3

Real GDP (Y)

 OUTWARD SHIFT IN SHORT-RUN AGGREGATE SUPPLY
General Price SRAS2
Level (GPL)
SRAS1

A decrease in costs SRAS3

for firms throughout GPL1
the economy will
cause an outward
shift of SRAS from
SRAS1 to SRAS3.
More can be
produced at each
general price level.

Y2 Y1 Y3

Real GDP (Y)

Shifts in
Short Run
Aggregate
Supply
 What factors can cause
a shift in the short run
aggregate supply
curve?

AGGREGATE SUPPLY SIR BURUNGUDZI

When focusing
on shifts in
SRAS – think
COSTS!
FACTORS CAUSING SHIFTS IN SHORT RUN AGGREGATE SUPPLY
Impact on unit costs (rise Inward or outward shift of short
Economic change
or fall) run aggregate supply
Stronger UK pound versus the US dollar ($) from £1=$1.20 to
£1=$1.50

Government increases national minimum wage by 10%.

Government increases national minimum wage by 4% and

labour productivity rises by 10%
UK leaves the EU without a trade deal and the UK imposes
average tariffs of 11% on EU imports
The government cuts a subsidy paid to UK farmers. (A subsidy
is financial assistance)
There is a rise in the global price of raw materials imported into
the UK economy

AGGREGATE SUPPLY SIR BURUNGUDZI

FACTORS CAUSING SHIFTS IN SHORT RUN AGGREGATE SUPPLY
Impact on unit costs (rise Inward or outward shift of short
Economic change
or fall) run aggregate supply
Stronger UK pound versus the US dollar ($) from £1=$1.20 to
Unit costs fall Outward shift of SRAS
£1=$1.50

Government increases national minimum wage by 10%.

Government increases national minimum wage by 4% and

labour productivity rises by 10%
UK leaves the EU without a trade deal and the UK imposes
average tariffs of 11% on EU imports
The government cuts a subsidy paid to UK farmers. (A subsidy
is financial assistance)
There is a rise in the global price of raw materials imported into
the UK economy

AGGREGATE SUPPLY SIR BURUNGUDZI

FACTORS CAUSING SHIFTS IN SHORT RUN AGGREGATE SUPPLY
Impact on unit costs (rise Inward or outward shift of short
Economic change
or fall) run aggregate supply
Stronger UK pound versus the US dollar ($) from £1=$1.20 to
Unit costs fall Outward shift of SRAS
£1=$1.50

Government increases national minimum wage by 10%. Unit costs rise Inward shift of SRAS

Government increases national minimum wage by 4% and

labour productivity rises by 10%
UK leaves the EU without a trade deal and the UK imposes
average tariffs of 11% on EU imports
The government cuts a subsidy paid to UK farmers. (A subsidy
is financial assistance)
There is a rise in the global price of raw materials imported into
the UK economy

AGGREGATE SUPPLY SIR BURUNGUDZI

FACTORS CAUSING SHIFTS IN SHORT RUN AGGREGATE SUPPLY
Impact on unit costs (rise Inward or outward shift of short
Economic change
or fall) run aggregate supply
Stronger UK pound versus the US dollar ($) from £1=$1.20 to
Unit costs fall Outward shift of SRAS
£1=$1.50

Government increases national minimum wage by 10%. Unit costs rise Inward shift of SRAS

Government increases national minimum wage by 4% and

Unit costs will fall Outward shift of SRAS
labour productivity rises by 10%
UK leaves the EU without a trade deal and the UK imposes
average tariffs of 11% on EU imports
The government cuts a subsidy paid to UK farmers. (A subsidy
is financial assistance)
There is a rise in the global price of raw materials imported into
the UK economy

AGGREGATE SUPPLY SIR BURUNGUDZI

FACTORS CAUSING SHIFTS IN SHORT RUN AGGREGATE SUPPLY
Impact on unit costs (rise Inward or outward shift of short
Economic change
or fall) run aggregate supply
Stronger UK pound versus the US dollar ($) from £1=$1.20 to
Unit costs fall Outward shift of SRAS
£1=$1.50

Government increases national minimum wage by 10%. Unit costs rise Inward shift of SRAS

Government increases national minimum wage by 4% and

Unit costs will fall Outward shift of SRAS
labour productivity rises by 10%
UK leaves the EU without a trade deal and the UK imposes
Unit costs will rise Inward shift of SRAS
average tariffs of 11% on EU imports
The government cuts a subsidy paid to UK farmers. (A subsidy
is financial assistance)
There is a rise in the global price of raw materials imported into
the UK economy

AGGREGATE SUPPLY SIR BURUNGUDZI

FACTORS CAUSING SHIFTS IN SHORT RUN AGGREGATE SUPPLY
Impact on unit costs (rise Inward or outward shift of short
Economic change
or fall) run aggregate supply
Stronger UK pound versus the US dollar ($) from £1=$1.20 to
Unit costs fall Outward shift of SRAS
£1=$1.50

Government increases national minimum wage by 10%. Unit costs rise Inward shift of SRAS

Government increases national minimum wage by 4% and

Unit costs will fall Outward shift of SRAS
labour productivity rises by 10%
UK leaves the EU without a trade deal and the UK imposes
Unit costs will rise Inward shift of SRAS
average tariffs of 11% on EU imports
The government cuts a subsidy paid to UK farmers. (A subsidy
Unit costs will rise Inward shift of SRAS
is financial assistance)
There is a rise in the global price of raw materials imported into
the UK economy

AGGREGATE SUPPLY SIR BURUNGUDZI

FACTORS CAUSING SHIFTS IN SHORT RUN AGGREGATE SUPPLY
Impact on unit costs (rise Inward or outward shift of short
Economic change
or fall) run aggregate supply
Stronger UK pound versus the US dollar ($) from £1=$1.20 to
Unit costs fall Outward shift of SRAS
£1=$1.50

Government increases national minimum wage by 10%. Unit costs rise Inward shift of SRAS

Government increases national minimum wage by 4% and

Unit costs will fall Outward shift of SRAS
labour productivity rises by 10%
UK leaves the EU without a trade deal and the UK imposes
Unit costs will rise Inward shift of SRAS
average tariffs of 11% on EU imports
The government cuts a subsidy paid to UK farmers. (A subsidy
Unit costs will rise Inward shift of SRAS
is financial assistance)
There is a rise in the global price of raw materials imported into
Unit costs will rise Inward shift of SRAS
the UK economy

AGGREGATE SUPPLY SIR BURUNGUDZI

FACTORS CAUSING SHIFT IN SHORT RUN AGGREGATE SUPPLY

 Unit wage costs perhaps arising from a higher minimum wage.

 Labour productivity (increased efficiency lowers the unit costs of supply).
 Key raw material and component prices such as glass, cement and rubber and
energy costs such the world price of oil, gas and electricity & renewables.
 Business indirect taxes, subsidies, VAT, environmental & employment taxes.
 Cost of imported materials (affected by movements in a country’s exchange rate
+ fluctuations in global prices)
 Supply Shocks: E.g. A hurricane, impact of drought, flooding or a political crisis.
Impact of a lockdown because of a public health crisis during a pandemic

AGGREGATE SUPPLY SIR BURUNGUDZI

 What are supply
shocks?

AGGREGATE SUPPLY SIR BURUNGUDZI

 Supply Shocks

Supply-side shocks affect short run aggregate supply

and can also affect a country's long-run productive
potential. Examples of supply shocks might include:
• Steep rise in oil and gas prices or other
commodities used in production
• Political turmoil / civil unrest / major strikes
• Supply shut-downs caused by a public health
crisis
• Natural disasters causing a sharp fall in production
• Unexpected breakthroughs in production
technology (example of favourable supply shock)
Examine the impact of a rise in business taxes on short run aggregate supply (SRAS)
One example of a new
business tax might be
the introduction of a
carbon tax set at £50 per
tonne of C02 emitted.
If there is a switch
towards cleaner energy
and less polluting
manufacturing, the
carbon tax might have
less impact on SRAS.
A tax adds to the costs
of producers. A power
company would now
face increased costs of
supplying energy to the
national grid.
The extent of the shift
depends on how much
carbon is emitted by
individual businesses
and the economy.
If we assume other costs
stay the same, then a
carbon tax would lead to
an increase in unit costs
across much of the
economy.
As a result, there will be
an inward shift of the
short-run aggregate
supply curve.
Examine how an appreciation of a currency can impact on SRAS

A currency appreciation One effect of a stronger For example, crude oil

means one currency can currency is that the and gas is priced in
buy more of another price of imports (priced dollars. A stronger
e.g. the pound moves in a domestic currency) pound will make it
from £1 buys $1.20 to falls. cheaper for the UK to
£1 buys $1.40 import energy.

We are assuming here This fall in unit costs will As a result, if energy
that other costs lead to an outward shift prices fall, the costs of
affecting producers have in short run aggregate many producers such as
not changed (i.e. we are supply meaning that car manufacturers will
assuming ceteris more can be produced also go down.
paribus) at each price.
 EXTRNAL SHOCKS AND AGGREGATE SUPPLY
Commodity prices
Short run aggregate supply
might shift inwards if there is
an unexpected rise in the
global price of essential raw
materials and energy for
countries that are net
importers of these products.
AGGREGATE SUPPLY
Volatile Exchange Rates Level of Net Migration
Net migration is the net
balance of people coming
into a country minus those
who are leaving. Migration
flows can be quite volatile
from year to year.
Import tariffs
SIR BURUNGUDZI