Getting Started with Aggregate Supply

You're looking at one of the most important concepts in A-Level Economics - aggregate supply (AS). It's simply the total productive capacity of the entire economy, or the sum of what all businesses can produce together.

The key thing to remember is that aggregate supply behaves differently in the short run versus the long run. In the short run, it's quite flexible - when prices rise, firms get excited about higher profits and temporarily boost production by paying workers overtime or running machines longer hours.

Quick Tip: Think of short-run AS like a rubber band - it can stretch temporarily, but it will eventually snap back to its normal position.

Understanding the difference between movements along the AS curve (caused by price changes) and shifts of the entire curve (caused by changes in production costs) will save you marks in your exams. When aggregate demand increases, you move along the curve. When production costs change, the whole curve shifts.

What Makes Short-Run Aggregate Supply Shift

Here's where it gets practical - short-run aggregate supply (SRAS) shifts when the costs of production change. You'll want to memorise these key factors because they're exam favourites.

The big players are raw material prices (especially oil), exchange rates, taxes and subsidies, and wages. When oil prices spike, for example, it becomes more expensive for firms to produce everything from electricity to transport, so SRAS shifts left - meaning less output at every price level.

Supply-side shocks are dramatic examples of SRAS shifts. The 1970s oil crisis trebled energy costs overnight, causing both inflation and recession simultaneously. The 2008 oil price surge did something similar just as the financial crisis hit.

Exam Success: Remember that a leftward SRAS shift always means higher prices and lower output - this combination is called stagflation.

Currency devaluation is another crucial factor. When the pound weakens, imported raw materials become more expensive, shifting SRAS left and potentially triggering inflation even without any increase in demand.

Long-Run Aggregate Supply - The Big Picture

Long-run aggregate supply (LRAS) is about the economy's fundamental capacity to produce - think bigger picture than just paying for overtime. This depends on your country's population, technology, capital stock, and productivity.

The factors affecting LRAS read like a government's economic wishlist: better education and skills, improved infrastructure, technological advances, and smart investment in capital. Net migration has boosted the UK's LRAS over the past decade by expanding the labour force.

Government policies play a massive role here. Supply-side policies like education reform, deregulation, and privatisation can shift LRAS rightward by making the economy more efficient. A stable political climate encourages entrepreneurs to invest and innovate.

Key Insight: Unlike SRAS, changes to LRAS represent permanent improvements (or deteriorations) in the economy's productive capacity.

The strength of the financial system matters too. Banks that can lend effectively help firms invest in new technology and expansion, while banking crises can damage long-term productive capacity - as we saw after 2008.

Classical vs Keynesian Views of LRAS

This is where economics gets interesting - economists actually disagree about what LRAS looks like, and this disagreement shapes entire government policies. The Classical view says LRAS is completely vertical (inelastic), while Keynesians believe it can be more flexible.

Classical economists think markets are efficient and flexible. In their world, wages and prices adjust quickly, so the economy naturally gravitates toward full employment. This means increasing demand just causes inflation without boosting long-term output.

Keynesians are more pessimistic about market flexibility. They argue that wages can be "sticky" $especially downward - try cutting someone's pay!$ and markets don't always clear efficiently. This means economies can get stuck below full employment for extended periods.

Exam Strategy: Always evaluate which AS model you're using, as it completely changes your policy recommendations.

The practical implications are huge. If Classicalists are right, expansionary fiscal policy just wastes money on inflation. If Keynesians are right, government spending can genuinely boost output and employment, especially during recessions.

The Phillips Curve - Trading Off Unemployment and Inflation

The Phillips Curve reveals one of economics' most important trade-offs: you often can't have both low unemployment and low inflation simultaneously. This relationship explains many government policy dilemmas you see in the news.

When governments boost aggregate demand (through spending or cutting taxes), unemployment typically falls as firms hire more workers to meet increased demand. However, as the economy approaches full capacity, this creates inflationary pressure - too much money chasing too few goods.

Think of it practically: if unemployment drops from 6% to 3%, inflation might rise from 2% to 5%. Politicians love the first bit (more jobs) but hate the second (higher prices for voters).

Real-World Application: This trade-off explains why central banks raise interest rates when unemployment gets "too low" - they're trying to prevent runaway inflation.

Monetarists add a crucial twist: they believe this trade-off only works temporarily. In their long-run Phillips Curve model, unemployment returns to its "natural rate" regardless of inflation policy, making demand-side policies ultimately ineffective for reducing unemployment.