Question

Other things remaining unchanged, the flatter the aggregate supply curve:

Answer 1

Aggregate supply (AS), also known as total supply is the total production of goods and services which is supplied in an economy at a given price level during a given period of time. It is a function of price level and real output (Gross Domestic Product or GDP), where price level is plotted on the vertical axis and real output on the horizontal axis. AS curve can be of two types:

(i)The Short Run Aggregate supply curve (SRAS) : In the short run, at least one factor of production has to be fixed. Thus, SRAS is the total supply of real output in the economy when some resources are fixed in quantity. For example, in the short run usually labour is variable because it is easy to change levels of labour intake, but capital is fixed because at short notice it is not always possible to vary levels of capital according to one’s needs. Therefore to bring in changes in output, labour has to be varied. Here the SRAS is horizontal, also known as the Keynesian AS curve as shown in figure 1.

(ii) The Long Run Aggregate supply curve (LRAS): This is the other extreme of aggregate supply where all factors of production are variable. No input prices are assumed to be fixed and the LRAS curve is vertical. This means that price level is completely flexible and this level represents the potential output of an economy, i.e. the maximum level of real output that can be produced with the given resources and technology. This is also known as the Classical AS curve, as shown in figure 2.

Another type of AS curve is the Medium Run AS which falls in between SRAS and LRAS. Here real output has a positive relationship with price level and price level rises (falls) when real output rises(falls). This is shown in figure 3.

If the AS curve moves from being steeper to flatter, the economy moves from a level of completely flexible labour, wages and capital to more rigid price levels. As the AS curve moves clockwise from AS’ to AS”, the AS curve gets flatter. Wages and prices start becoming stickier and more inflexible. The variables do change, but adjust more slowly to short-term fluctuations in the economy. This phase is known as the New-Keynesian AS curve. Here, as prices change, higher price makes more production profitable and enable business to expand.

As AS” shifts further clockwise to AS”’, it become flatter until the point at which it becomes horizontal. This is known as the Keynesian AS curve. At that point, the wages and prices, which fall under the general price level are completely sticky and inflexible. Under this scenario, real output increases because existing capital is more intensively used and the unemployed begin to join the labour force and produce more. This approach is completely demand oriented as the amount of output supplied depends totally on demand. As opposed to this, when the AS curve was vertical, there was a supply-side view. The demand depended completely on the amount supplied.

To sum up, other things remaining constant, as the AS curve becomes flatter, the economy moves from flexible price level and full employment equilibrium to fixed price levels and an equilibrium where unemployment exists due to lack of effective demand. The changes in AS are shown in figure 4.