Shifting the Aggregate Supply Curve - Essay Example

Economics Table of Contents a) Define Aggregate Supply and, using a diagram, explain three Factors that might Cause the Aggregate Supply Curve to Shift. Use Examples of the UK and Other Countries to Help Illustrate these Factors. 3 Introduction 3 Definition of Aggregate Supply (AS) 3 Explanation of the Three Key factors leading to Shift the AS Curve 4 Economic Growth 4 Change in Input Price 5 Substitution Effect of Goods/Services 5 Conclusion 6 b) Analysing the Keynesian and Neo-Classical Theories of Aggregate Supply and Critically Evaluate whether or not an Improving AS is the most Effective way to achieve the Governments’ Objectives 7 Introduction 7 Keynesian Theory of Aggregate Supply 7 Neo-Classical Theories of Aggregate Supply 10 Critical Evaluation of whether or not an Improving AS is the most Effective way to achieve the Governments’ Objectives of Steady Growth, Low inflation and Low Unemployment 11 Conclusion 13 References 15 a) Define Aggregate Supply and, using a diagram, explain three Factors that might Cause the Aggregate Supply Curve to Shift. Use Examples of the UK and Other Countries to Help Illustrate these Factors. Introduction The term aggregates supply is considered as one of the major determinants of macroeconomics, which primarily refers to considerably large groupings of supply that may be goods and/or services or of the people in a particular country. According to an academic understanding, term aggregate is recognised on the basis of demand and supply which include Aggregate Demand (AD) and Aggregate Supply (AS) (Gwartney & et. al., 2012). In this essay, the discussion highly focuses on the concept of Aggregate Supply (AS). The discussion also incorporates an analysis of three key factors that might cause the AS curve to shift using appropriate graphical illustrations. Additionally, the discussion includes the example of the UK in terms of analysing the major influencing factors on the country’s aggregate supply portfolios. Definition of Aggregate Supply (AS) The concept of Aggregate Supply (AS) in economics principally represents the existing relationship among the price and the quantity level with the total amount of goods or services supplied. In general, the concept of AS refers to the overall supply of commodities and services produced within a particular nation (Mankiw, 2014). Explanation of the Three Key factors leading to Shift the AS Curve The changes in the AS curve are generally influenced by a number of factors of a particular nation. However, the change in the AS curve shift is primarily influenced by three key factors that include economic growth, change in input price and substitution effect of goods/services of that particular country. Economic Growth The positive growth rate in an economy is resulted by the increase in productive resources including labour and capital of a country. The availability of abundant labour and/or capital resources helps to produce extensive numbers of final goods and/or services as well as provide support to increase the annual GDP growth rates. In this regard, a positive growth rate of economy of a country is represented by a shift towards the right of the AS curve. On the other hand, the lower growth rate of economy represents shift towards the left side of the AS curve (Mankiw, 2014). In relation to the current economic performance of the UK, the country has been witnessing unabated fluctuation in terms of maintaining a stable economic position. Although, continuous fluctuation raises major difficulties for the UK in terms of stabilising economic growth, but the presence of wide range of long-term productive resources have been observed to facilitate the nation to achieve continuous growth of GDP rates along with annual household income (Sexton, 2010). Change in Input Price Change in input price is regarded as one of the major influencing factors leading to the shift of AS curve. A decrease in the AS is significantly resulted due to a significant increase in the input prices of goods/services in a particular nation. For example, the organisations from oil based product manufacturing industry in the UK have faced major challenges due to the increase in input price, while the organisations had faced issues in purchasing resources from oil-exporting countries. In addition, the organisations from both Asia Pacific and European regions have also been observed to increase the price of their oil-based and other types of petroleum products due to the rising costs relating to the procurement of adequate amount of oil from the different suppliers across the global oil export nations. The increasing costs in the procurement of oil based resources frequently imposed these countries to change the price of their various products/service with the intention of coping increased cost in the economy (Mankiw, 2014; Sexton, 2010). Substitution Effect of Goods/Services Substitution effect in products and/or services is also a major factor leading to change the trend of AS curve. In this context, the large availability of substitute products and/or services significantly imposes organisations to make changes in their product/service prices due to the existence of substitute items for better business sustainability (Burton & Brown, 2009). Conclusion The concept of aggregate supply tends to apparently measure the level of goods and/or services produced at a stipulated overall price level of an economy. According to the conventional economic concept, the level of aggregate supply has a strong relationship with general price level of goods and/or services. The increase in price is an indication for firms or governments to effectively address the rising level of aggregate demand in markets or countries. Based on the aforesaid discussion, the factors that include economic growth, change in price of commodities and substitution effects of goods/services are few of the factors leading to the shift of aggregate supply. Moreover, the size and the quality of both the capital stocks along with labour market have also been identified to have major impact in the shift of aggregate supply curve. b) Analysing the Keynesian and Neo-Classical Theories of Aggregate Supply and Critically Evaluate whether or not an Improving AS is the most Effective way to achieve the Governments’ Objectives Introduction According to the historical evolution of the concepts and the principles of economic theories, it has been critically identified that Aggregate Supply (AS) tends to have major impact on the growth and depression aspects of an economy, employment and inflation rates among others of a particular nation (Dutt & Skott, 2005). In this regard, the section emphasises an in-depth understanding by analysing Keynesian and Neo-Classical concept of aggregate supply and critically evaluate whether or not improving AS is the most effective way to achieve the governments’ objectives. Keynesian Theory of Aggregate Supply The Keynesian theory of aggregate supply primarily depicts about the general philosophy regarding the functional roles of an economy and its influences on employment, interest rates along with financial performances of a nation. In relation to the theoretical depiction, it is evident that considerable inflexibilities in wage and price of goods can substantially increase or form a long-term crisis on the country’s employment sectors. More significantly, unemployment can be a prolonged issue generating due to the inflexibility of price and wage. In this respect, the Keynesian theory of aggregate supply is identified to be influenced immensely by spending in an economy i.e. aggregate demand (Dutt & Skott, 2005). The theory simply defines that demand for any commodity or service tends to create its own supply. In this regard, it can be critically considered that the increasing rate of employment cannot be attained, except the economy of a country trapped in a more critical depression or recession. According to an in-depth understanding of the theory, it has been critically anticipated that during a severe recession or economic depression, a country significantly possess a wide range of idle economic resources that can be effectively utilised to refurbish the economic growth or reduce the rate of unemployment. Therefore, the producers or the manufacturing organisations of countries are more willing to sell additional output at a current market pricing structure owing to the availability of putting upward pressure on price for each product/service (Dutt & Skott, 2005; Cengage Learning Higher Education, n.d.). The following pictorial illustration depicts the core Keynesian theory of aggregate supply in the context of economy depression or recession. Fig: Keynesian Horizontal Aggregate Supply Curve Source: (Cengage Learning Higher Education, n.d.) With reference to the above illustration of Keynesian theoretical model, it has been clearly observed that the aggregate demand elevated from AD1 to AD2 results to create a new equilibrium at E2 level. In relation to the Keynesian assumptions relating to the fixed price level, it has been identified that the changes have been taken place in the real GDP of the AS curve. In this regard, the Keynesian theory significantly argues that the shifts in Aggregate Demand (AD) possess the potential to refurbish the economic recession to a full employment within a nation (Cengage Learning Higher Education, n.d.). Respectively from the understanding of Keynesian theory, it has been clearly identified that the horizontal position of the AS curve is a significant effect of a substantial increase in the AD as a form of increasing GDP rates whereas the price level remains the same. In this regard, it can be stated that the Keynesian theory of aggregate supply clearly denotes that “demand creates its own supply” (Cengage Learning Higher Education, n.d.). Neo-Classical Theories of Aggregate Supply Despite the Keynesian theory, the concept of neo-classical concept of aggregate supply provides a distinctive approach with regard to the supply and the demand. In relation to the neo-classical model, the theory might have dissimilar reaction both in the short-run and long-run equilibrium (Dutt & Skott, 2005). According to the neo-classical theory, it is clearly observed that an increase in the aggregate demand within a short-run equilibrium leads to an increase in output, however the flow might also increase the price. Short-run equilibrium can take place in firms experiencing diminishing outputs and are significantly forced to increase the price of commodities with the aim of preventing the higher level of products and/or services costs. With respect to the neo-classical principles, the increase in AD may take place for various reasons such as lower taxation rates, increasing expenditure of the government and significant increase in supply of wealth (Dutt & Skott, 2005). In the long-run, the scenario can be identified to be quite dissimilar as compare to the AS curve in long-run equilibrium. In relation to the neo-classical model of aggregate supply, the economy will be inclined towards achieving full employment on its own, which would further result to an increase in demand. In this regard, the shape in the long-run AS curve is vertical. The aggregate supply curve in the long-run is therefore vertical at the full employment level of output. Any type of increase in aggregate demand in this situation leads to increase the price, without increase in overall output (Dutt & Skott, 2005). Critical Evaluation of whether or not an Improving AS is the most Effective way to achieve the Governments’ Objectives of Steady Growth, Low inflation and Low Unemployment In the context of government’s objective of achieving steady growth of an economy in relation to lower inflation and lower unemployment, the shift of aggregate supply can be considered as one of the crucial determinants within a country. The following discussion therefore, determines the role of improving aggregate supply on governments to achieve their wide ranging economic objective objectives. Steady Economic Growth The steady growth of economy can be achieved by a nation through practicing long-term aggregate supply, as it is simply determined by the stocks associated with the economic resources of a country. Moreover, the steady growth of an economy is also influenced by the key productive sources such as labour, capital and lands that are likely to play a crucial role to increase the overall output that can enable a government to meet the increasing demand within a country. Integrating changes in technology or ensuring continuous development of the infrastructure can also lead to improve the economic performance of a country, which can only be achieved by the government of a country through practicing long-run aggregate of supply. According to the traditional principles of aggregate supply, it has been ascertained that the changes relating to demand as well as supply of products and/or services in an economy are likely to alter the natural growth rate of output, which significantly shifts long-run aggregate supply. Making continuous improvement in the productive resources or any increase in capital stock may lead the government of a country to shift the long-run aggregate supply that can further enable to achieve steady economic growth (Gwartney & et. al., 2012). Lower Inflation The rate of inflation is generally attributed as one of the key variables behind the shift in aggregate supply of a particular nation. According to the concept of classical economic theories, the vertical slopping of the aggregate supply represents that the economic position of a nation will always be able to conserve strong growth of real GDP, which indeed facilitate a nation to strongly avoid any type of economic recession or inflation gap. The rise in inflation rate is most often considered as a major challenging issue for any country to gain adequate pace in economy (Windward Community College, n.d.). The increase in inflation rate tends to create major hurdles for a government to grasp control over demands, as the situation generally impose significant hikes in the aggregate supply due to the rising cost of the commodities. However, continuous decline of inflation rates can further pose different challenges in a country, as the scenario often leads to lower the demand and restrict the annual output from the wide range of productive resources. In this regard, a better control in the aggregate supply by considering the movement of aggregate demand can lead to form an effective inflation rate, which might enable governments to stabilise different macroeconomic factors such as employment rate, annual GDP and household income among others (Gwartney & et. al., 2012). Lower Unemployment Rate The continuous improvement of aggregate supply can further be consider as one of the most effective mechanisms to lower the major challenge of unemployment within a nation. In general, the concern associated with increasing rate of unemployment can be regarded as an independent variable in a particular long-run economy, because the rate of unemployment within a nation is determined by the key features existing within the labour market. In the context of short-run economy however, the concept of unemployment is correlated with a country’s inflation rate. This can be stated due to the fact that the increase in aggregate demand is often observed to temporarily increase the inflation rates along with annual output while it highly focuses on lowering the unemployment rates (Gwartney & et. al., 2012; Windward Community College, n.d.). Hence, the improvement of aggregate supply will assist governments to achieve major four economic aims that include steady economic growth, lower inflation, lower unemployment rate and formulation of effective monetary policies. Conclusion In the context of short-run, the aggregate supply is primarily determined by the performance of supply side within an economy. It basically tends to reflect the actual productive capability along with production costs across each sector of an economy. On the other hand, the long-run aggregate supply is primarily determined by the productive resources that are available to effectively meet the increasing demands. Moreover, the aggregate supply in the long-run is also determined by the productivity level of different input factors including capital, labour and land among others. Based on the aforesaid discussion, it has been ascertained that continuous improvement in aggregate supply tends to increase the capability of governments in terms of achieving their objective of gaining steady economic growth and lower inflation as well as unemployment rates in a country. References Burton, M. & Brown, B., 2009. The Financial System and the Economy Fifth Edition. M.E. Sharpe. Cengage Learning Higher Education, No Date. Aggregate Demand and Supply. Chapter 20. [Online] Available at: http://www.swlearning.com/ibc/tucker3e/pdf/Tucker_ch20.pdf [Accessed June 21, 2014]. Dutt, A. K. & Skott, P., 2005. Keynesian Theory and the AD-AS Framework: A Reconsideration. Introduction. [Online] Available at: http://www.umass.edu/economics/publications/2005-11.pdf [Accessed June 21, 2014]. Gwartney, J. & et. al., 2012. Macroeconomics: Private and Public Choice. Cengage Learning. Mankiw, N., 2014. Principles of Macroeconomics. Cengage Learning. Sexton, R., 2010. Exploring Macroeconomics. Cengage Learning. Windward Community College, No Date. The Short-Run Trade-off between Inflation and Unemployment. Chapter 35, pp. 1-19. Read More