Aggregate Supply Total amount of goods and services that all industries in the economy will produce at every

given price level. Sum of the supply curves in the industry Short run aggregate supply o Short run aggregate supply curve resembles that of microeconomic supply curve = upward sloping curve. o Positive relationship between price level and amount of output that country's industries will apply o At any given level, the industry will supply a certain level of output. o Macroeconomic short run means that all prices of factors of production are fixed especially price of labor, wage rate during a period of time. o Larger level of output = higher costs of production. o In order to produce more, the workers would have to work more and they would do so if provided with incentives like overtime wages. o Law of diminishing returns means that marginal and average costs will rise as output increases in the short run = increase in output will result in an increase in average costs = upward sloping curve. Shifts in SRAS o Show the relationship between the average price level and the level of national output under the ceterius paribus, factor costs remain constant. o A change in anything other than price will lead to a shift in the whole SRAS curve = supply side shocks. o A decrease in costs = increase in aggregate supply o An increase in costs = decrease in aggregate supply o A change in wage rates An increase in wage rates = decrease in aggregate supply. If government sets minimum wage control = decrease in aggregate supply. Labour unions in manufacturing factories are able to negotiate higher wages = decrease in aggregate supply. o A change in the costs of raw materials Significant increase in the price of significant, widely used raw materials = fall in SRAS. An example would be oil. o A change in the price of imports Capital/ raw materials used by a country's industries are imported, then a rise in import prices = increase costs of production = decrease in SRAS. Changes in the exchange rate of country's currency = changes in import rates. o Change in government indirect taxes/ subsidies Increase in indirect taxes = increase in the costs of production = fall in SRAS curve. Fall in indirect taxes = increase in SRAS. Subsidies are a payment from government to firms = increase in subsidy = decrease costs of production = increase in SRAS. Combining AD and AS in the short run o Aggregate demand = Aggregate supply = macroeconomic equilibrium o At average price level, all output produced by country's producers is consumed. o There is no incentive for producers to either increase output/ raise prices.

Long run aggregate supply o Two shapes of AS curves New classical LRAS Different branches of economists including monetarists, supply side economists, and economists from the Austrian school = efficiency of market forces and very minimum government intervention in allocation of resources. LRAS curve is perfectly inelastic/ vertical at full employment level of output, potential output that could be produced if the economy were operating at full capacity. Full employment does not mean zero employment. Potential output is based entirely on quantity and quality of the factors of production and not on the price level. LRAS is independent of the price level. The price level might rise but the level of output would remain the same. Keynesian AS o Three possible phases o No distinguition between short run and long run o

o o

Phase 1 Aggregate supply curve is perfectly elastic at low levels of economic activity. Producers can increase output without having to pay the extra production costs because of spare capacity, high levels of unused factors such as unemployed labour + under utilized capital. More output = maximize these factors of production at average current costs. Phase 2 Potential output = Y1 = spare capacity is used up = available factors of production become increasingly scarce. Producers continue to try to increase their output = bid for the increasingly scarce factors. Higher prices for the factors of production = higher costs for the producers = price will go up to compensate for the higher costs. Upward sloping LRAS Phase 3

When economy reaches its full capacity = all factors of production are employed & impossible to increase output = LRAS is perfectly inelastic. At this stage, output cannot be increased without an increase in the quantity or improvement in the qulity of the factors of production.

Shifts in the SRAS o Constantly changes in the domestic factors of production = steady increases in LRAS which is an effective illustration of potential economic growth. o An outward shift in LRAS = productive potential has increased. o A shift of LRAS = outward shift of the production possibilities curve (this is a curve with consumer goods and services, on y-axis, and capital goods, on x-axis. o Shift to the right= improvement in the quality of the factors of production/ increase in the quantity of the factors of production o Improvement in the quality = increase in productivity, output per unit of output, of the resources used in production o Both can be affected by advances in technology o Advances in technology vital for supply side of the economy

Sources of these supply side changes come naturally through market forces o Students = engineering, scientific research or entrepreneurship because they want to earn higher wages o Immigrants attracted to a foreign country = better standards of living o Business = higher profits = engage in research and development to improve productivity of their resources. o Raw material producers = profit motive = develop improved resource extraction technologies o Government contribution is important too, o Government policies to increase the quantity/quality = supply side policies. o Two supply side policies Interventionist policies Market based policies Supply side policies o Increase potential output of the economy = increase in the quantity/quality of factors of production

Interventionist supply-side policies Government has an important role in encouraging growth Investment in human capital Increase in productivity/ quality of countrys labor force = education + training Education = positive externalities because educated and trained workforce = increase potential output Education and training = provided in a pure market and thus would be underprovided Governments responsibility to ensure that the education facilities are tailor made for countrys circumstances and to provide skills + knowledge for new workers and retraining for old workers (changing economic circumstances) . Schools, universities, training institutions, apprenticeship programmes, private institutions with subsidies/ tax benefits. Help to raise the human capital of an economy Research and development Firms stay updated with modern developments and to develop new production techniques, they need to spend extensively on research on development. To promote research and development, governments might not tax the retained profits which are being used specifically for research and development, tax credit. Firms might not want to spend extensively on research and development if their research is going to be manipulated by other firms, for assurance, the government guarantees intellectual property rights such patents and copyrights. Governments could also finance research and development in public institutions Provision and maintenance of infrastructure Infrastructure = large scale capital, usually provided by the government = necessary for economic activity to take place. Roads, electricity, water supply, sanitation, waste management, railways, airports, ports, telecommunications, internet access, public transportation, institutoins such as education and health systems/ legal and security framework. Productive potential of an economy is illustrated by its LRAS which is enhanced by improved infrastructure. Direct support for businesses and industrial policies Agencies/ ministries = responsible for developing policies = support and encourage the development of industry (ministry of trade, ministry of commerce) Mandates = improving competition through maintenance of antimonopoly laws, helping small and medium enterprises to be able to stand on their own and grow, supporting export companies in their access to markets abroad, advising government on how education can meet the needs of businesses. Along with tax credits, can support certain industries through financial subsidies. Interventionist policies = necessary in an economy controversial.

They have traits of merit goods = provided in a market system = would be underprovided. The economy would not benefit from the potential welfare gain in terms of greatest possible increase in LRAS. Government intervention is needed. Each policy = demand side and supply side effect Government spending increases aggregate demand in the economy and aims to increase aggregate supply however; they demand side effects will be felt quickly than supply side effects, long time for before implementation of these policies and their effect on potential output. The extent to which they are facilitates would be dependent on budget constraints as spending so much money from a government budget involves opportunity cost. Also dependent on the ideological aims of the government and power of various interest groups. Controversies = provision and funding of education. Science stream vs arts stream / disagreement on types of examinations. Market based supply side policies Freedom to markets with minimal government intervention Incentives policies = incentives for labor to work hard and more productively + incentives for firms to incest and in increase productivity. Institutional changes = affect the structures, institutions and rules that govern economic stakeholders. Reduction in household income taxes Higher taxes on higher income = people discouraged They would prefer more time for leisure than work as their extra income is going to make them pay more taxes. Decreasing income tax would provide them with incentives to work harder, earn more money and the more productive they are, the more money they earn = increasing potential output of the economy. Reductions in corporate taxes Keep more profits = more investment Investment is the addition of capital stock to the economy. Greater investment = more capital = increase in factor of production. Profits = research and development so more profits = more research and development = advances in technology If businesses know that they are going to keep larger share of their profits and have to pay less taxes, then they have an incentive to produce more and more efficiently More profits = better supply side effects Labor market reforms Reduction in trade union power o Trade union = protecting workers well- being, rights, and incomes. o Trade unions raise the costs of workers above level that would have been in a non- union environment o Reducing / eliminating (extreme) trade union power= reduce the ability of unions to negotiate higher costs of labor = lower costs of production = increase the number of workers that firms can hire

Reduction of elimination of minimum wages o Reduction / abolition of the government set minimum wage, which is higher than it would be in free market = decrease cost of labor = increase aggregate demand Reduction in unemployment benefits. o Unemployed given generous benefits from the government = no/ less incentive to find and take an available job. o Reducing unemployment benefits would encourage unemployed to take available jobs in the economy, given that jobs are available. Deregulation Many regulations on operations of businesses = increase their cost of production = reduce potential output of the economy. Environmental laws, health and safety regulations, laws concerning work hours, leave or holiday. Reduction in the number/ severity or both of regulations, deregulation = increase aggregate supply Privatization Sale of nationalized firms to the private sector. Free market economists = privately owned, profit maximizing firms are better and more efficient than nationalized firms = increase potential output of the economy. Nationalized firms = different goals than private firms = provision of a service to an isolated market/ maintenance of employment = they might operate inefficiently. Policies to increase competition Competition = encourages greater efficiency. Policies that increase competition = enforcing strict anti- monopoly laws = increase efficiency and improve the productive potential of an economy. International trade = trade liberalization = improve the efficiency of domestic firms. These market based policies emphasize the reduced role of the government in the economy and the importance of allowing all free markets, especially labor markets to operate freely without interference. Generate positive outcomes in economic growth Negative outcomes Possible reduction in living standards for low income/ unionized workers = increased income inequality. Negative consequences on the environment if environmental regulations are relaxed = negative externalities of production. Potential reduction in worker safety = health and safety regulations are relaxed + worsening in working conditions = regulations concerning working hours are changed.

Macroeconomic Equilibrium
National income = level of output that a country produces + key sign of economic health of economy The actual level of output + corresponding price level = aggregate supply + aggregate demand Equilibrium level of output = aggregate supply = aggregate demand Short run and long run aggregate supply = short and long run macroeconomic equilibrium Joblessness and rapidly rising prices = significant problems in economy Short run equilibrium output o = aggregate demand = aggregate supply SRAS ( y axis = real output and x axis = average price level) o Since aggregate demand = aggregate supply, the output produced by the economy = total demand in the economy = no need to change the level of output o Since aggregate demand = aggregate supply, there is no upward / downward pressure = no inflationary / deflationary pressure o No changes to aggregate demand / aggregate supply = equilibrium is maintained Long- run equilibrium output o = aggregate demand = long-run aggregate supply o New classical perspective vs. Keynesian perspective on the shape of the long- run aggregate supply curve o New classical perspective The economy will always long run equilibrium = full employment level of output = aggregate demand = aggregate supply curve

Average price level

LRAS

AD

Real output

The impact of changes in aggregate demand will be on the price level only = no increase in real output because LRAS is vertical. Short run adjustment long run Keynesian = New classical on short run equilibrium

But Keynesian New classical on long run equilibrium because new classical perspective is that the economy will always move towards the long run equilibrium automatically Automatically = without government intervention + important in understanding the significance of free markets, according to New Classical economists. = short run increase in output = increase in aggregate demand but the economy will always return to its long run equilibrium If aggregate demand increases, then the level of output will also increase in short run = inflationary gap, where the economy is in equilibrium at a level of output that is greater than the full level of output = but only possible in the short run, according to new classical economist. To increase output, the employers would have to increase wages because all sources are employed, as the level of output is greater than full employment level of output, thus, firms have to compete for the current scarce labor by bidding high prices which would increase the average price level = all prices in the economy have risen as firms continue to bid = increase output. The rise in price level = increase in prices of factors of production = increase in costs of production = SRAS shifts to the left because high output = high prices = high costs of production = no real gain = reduce output back to the original position = output returns to its full employment level, but at a higher price.

Long run equilibrium = AD = SRAS. If aggregate demand falls, then national output falls = decrease in the price level = deflationary gap. Deflationary Gap is when economy is in equilibrium at a level of output that is less than the full employment level of output. In short run = economy will produce at less than full employment level of output = lots of unemployed labor and unused resources because output < full employment level of output = price of factors of production has decreased = firms costs of production will fall and SRAS moves to the right = economy returns to its full employment level, but at a lower price. According to new classical perspective, long run equilibrium = full employment level of income ++ economy will move towards this equilibrium without any government intervention + with free market forces. Increase in aggregate demand = inflationary gap and no need for government intervention = let the market save itself (princess in shining armor) rather than using government policies to manage the level of aggregate demand Keynesian perspective =aggregate demand= long run aggregate supply The equilibrium level of output may occur at different levels Long run equilibrium output below the full employment level of national income = spare capacity (phase 1 of Keynesian perspective) the economy depends primarily on aggregate demand.

If aggregate demand is intersecting LRAS when it is perfectly elastic, then the output level is below the full employment level of output as there is many unused factors of production such as unemployed workers &/or underutilized capital (spare capacity) = deflationary gap Deflatinary gap- level of aggregate demand potential output that could be produced by economy at full employment level of output Also output gap= distance from the hypothetical production possibilities curve to a point on the curve. According to Keynesian, aggregate demand can increase such that there is an increase in the level of real output without any increase in price level (on the perfectly elastic part on the LRAS), possible due to spare capacity, as producers can employ unused factors of production without no increase in costs inflationary pressure Aggregate demand intersects with curving LRAS, scarce resources and bid prices = inflationary pressure, increasing prices to compensate for the higher prices to producers Aggregate demand intersecting at straight line LRAS, full employment. An increase in aggregate demand = purely inflationary = no change in real output + increasing real prices because impossible for economy to produce more in the long run as all current factors of production are employed Cannot produce more output + increasing prices at full employment level of output = inflationary gap Inflationary gap = level of aggregate demand satisfied with the existing resources = components of aggregate demand start bidding prices on the scarce resources Demand side policies Long run equilibrium level of output full employment level of income and that the economy can become stuck at a level of output that is below the full employment level of employment = significant complications and roles for government Government intervene to steer the economy towards full employment = demand side policies/ demand management policies fiscal + monetary policies introduced in aggregate demand Expansionary policies to increase aggregate demand which would increase equilibrium level of output = increasing demand for labor policies designed to reduce unemployment Contractionary policies = decrease aggregate demand when there is inflationary pressure = rising prices. Changes in long- run aggregate supply Countrys LRAS = quantity + quality of factors of production Quality + quantity of factors change = LRAS changes = full employment level of output rises Economic growth occurs = LRAS shifts to the right = increase in potential output of the economy Increase the rate of economic growth + full employment level of real output = supply side policies to increase the quantity + improve the quality of its factors of production

Impact of these policies = perspective of the economy Keynesian = increase in LRAS = initial equilibrium position of the economy. If economy is operating below the full employment level of output (spare capacity vala) = increase in LRAS will have no effect on the equilibrium output. Even though the potential output has increased but the aggregate demand is not enough to utilize this potential output and so the equilibrium does not change. Keynesian economists emphasize the importance of government intervention while acknowledging the importance of supply side policies in achieving growth New Classical viewpoint = If LRAS shifts, then the same aggregate demand curve will have different results. If LRAS shifts, the level of real output, increase in full employment level of output, increases while real price level falls = supply side economists = new classical economists. Supply side policies most effective in achieving countrys macroeconomic goals The multiplier effect Deflationary gap = increase government spending, then the increase in aggregate demand will be greater than the amount of spending. Any increase in aggregate demand = proportionately larger increase in national income = multiplier effect = withdrawals + injections Government spending + business investment = injections in the circular flow of income any injections are multiplied through the economy as people receive a share of their income + spend a part of what they receive When people receive income, then they save some, some is given the government as taxes and some is spent on imports and the rest is spent on domestic goods and services = the money spent on domestic goods and services goes in others pockets and then they do the same, their money spent on domestic goods and services is in somebody elses pockets who follows the same routine and their money goes in somebody elses pockets. Saving + spending on imports + taxes = leakages + withdrawals from the circular flow of income Income spent on domestic goods and services = marginal propensity to consume Marginal propensity to save (income saved) + marginal propensity to import (income spent on imports) + marginal rate of taxation (income which goes to government as taxes) = marginal propensity to withdraw The multiplier = Or Any change in any of the withdrawals from the circular flow = change in the economys multiplier Increasing taxation rate = value of multiplier will fall Income spent on imports (mpm) falls = increase in multiplier Government intervention to fill a deflationary gap = must have idea of two things

Estimate the gap between equilibrium output + full employment output. Estimate of the value of multiplier = judge the suitable increase in aggregate demand necessary to inject into the economy in order to fill the gap Difficulty in estimating both = limitations of government fiscal policy aimed at managing aggregate demand in the economy

17- Low Unemployment

Low level of umemployment = main macroeconomic goal of every government Low/ falling unemployment = healthy/ improved economy Unemployment = jobless Unemployment rate = how many jobs are created in the economy Number of jobs created will vary in different industries and for different people Different rates in different regions + will differ from the national average Many things affect the unemployment rate o Exchange rates o Costs of raw materials o International economic conditions Unemployment rate wage rates What is unemployment and how is it measured o International Labor Organization unemployment = people of working age, without work, available for work, actively seeking work o Unemployment rate = number of unemployed people expressed as percentage of the total labor force not the whole population o Labor force = work force, economically active population o Legal working age + retirement age - varies from country to country o People not within working age + people who do not want to/ not able to work = not included in work force + not considered to be unemployed because they are not actively seeking employment o Each country- own national system for measuring work force + estimating unemployment National censuses + surveys of the population Administrative records such as unemployment insurance records Social security information Inaccuracies in the data+ inconsistency in definitions across countries o Unemployment definition Based on people registered as unemployed Dependent on the incentive to register as unemployedunemployment benefits No benefits = no entitled to registration Calculated as the number of people who are claiming unemployment benefits o Hidden employment Several different groups of people Unemployed for a long time and have given up the search for work Have part time work but would like to work full time o Not considered unemployed o Do not have what they want and need o Any income is better than no income People who are working in jobs for which they are over qualified o Would like a job that utilizes their full skills o Any job is better than no job Distribution of unemployment o National unemployment rate = an average for a whole country inequlities among different groups within an economy.

Typical disparitites Geographical disparities Inner city unemployment might be bit higher than suburban or rural unemployment Most countries do have some regions that are more prosperous than others Age disparities Unemployment rates in under 25 age group are higher than the national averages in many countries Ethnic differences Ethnic minority = higher unemployment rates because of prejudice+ attitudes of employers / lack of education Gender disparities Unemployment for women > men because of differences in education, discrimination by employers +/ other social factors Costs of unemployment o Unemployment poses great costs to an economy o Unemployment increases the longer that people are unemployed o Costs of unemployment to the unemployed people themselves Unemployed people will receive less income than if they were employed lower standard of living. Longer the unemployment dejection + depression = higher levels of suicide o Costs of unemployment to society Poverty Higher rates of crime + vandalism Not completely related but neither are they completely unconnected o Costs of unemployment to the economy as a whole If actual output < potential output due to unemployment of means of production + labor = foregoing possible output an operating within its PPC. Loss of output possible income for the unemployed Increased opportunity cost of unemployment benefits. Lower incomes lower indirect taxes + lower consumer spending = less government income. o Costs of unemployment increase the longer the people are unemployed o Costs associated with long term unemployment Main factors affecting the level of unemployment o The relation between the unemployed and the employed will determine the rate of unemployment at any given time. o The factors causing the unemployment level to rise People who have lost jobs Resigned Left school, have not found work as of yet Trying to return to work after having left it Unemployed Immigrants o The factors causing the unemployment level to fall Find jobs Retirement Go back into education o

Stay at home Emigration to other countries Give up searching for jobs o Another determinant = demand for labor Causes of unemployment o The labor market

Demand for labor = aggregate demand for labor. The aggregate demand curve slopes downwards lower wage rate = more labor demand for labor increases and wages increase decrease workforce. o As wage rate increases more people are willing to work so the aggregate supply curve slopes upwards. o Equilibrium at L = aggregate supply = aggregate demand o Equilibrium unemployment o Disequilibrium unemployment Conditions that prevent the market from reaching the equilibrium, clearing. Real wage unemployment Cyclical unemployment o Frictional unemployment o Structural unemployment Demand side policies / supply side policies? Crowding out o o