Additional Revision Ecconotes

Revision notes on aggregate supply and demand for AQA AS Economics.

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  • Created on: 25-11-07 17:52
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Additional Revision notesChapter 15
Aggregate Supply and Demand
Explaining the shape and slope of the AD curve:
There are three factors which affect this:
1. The Wealth Effect(real balance effect) assuming a nominal stock of money (or money
supply) in an economy:
In price level people's real money balances
This makes people feel wealthier, so consumption increases which in turn means that
the demand for real output increases when the price level falls
2. Changes in real interest rates In basic supply and demand, when the supply of any
commodity exceeds demand, price tends to fall. Now say that the rate of interest is the
supply of money:
In the supply of
real money (relative real interest rates in consumption and
to demand) investment
3. The effect on the demand for exports and imports When the domestic price level
Demand for this country's exports rises
Demand for own produce rises
Demand for imports falls
Aggregate Supply
There are 2 very different aggregate supply curves:
The short run AS curve (SRAS) curve
The long run AS curve (LRAS) curve
Short run AS curves show the levels of real output that firms plan to produce and sell at
different price levels
Long run AS curves show the economy's capacity constraint at a particular point in time
The Keynesian "inverted L" shaped SRAS curve
The inverted L shape depended on assumptions about the economy's spare capacity.
It is horizontal as long as the economy produces inside the PPC (where there is unemployed
labour and spare capacity). This was due to 2 reasons:
1. When there was spare capacity, Keynesians assumed that workers are willing to supply
more labour without the wage rate rising.

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Keynesians assumed that the marginal product of labour is constant so when a firm
takes on an extra worker, the extra output produced by the worker is the same as that
produced by all the workers already hired.
These two assumptions mean that the marginal cost
of production remains constant as output rises until
full employment is reached. Given these
assumptions, firms are prepared to respond to an
increase in demand by increasing output, but no
increase to the price level.…read more

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The vertical LRAS curve
The SRAS curve shows the supply of real output in a time period when costs of production
such as money wage rates remain unchanged. The LRAS curve is vertical because it shows the
potential level of output that the economy is capable of producing. Potential output is not
affected by the price level, hence the LRAS curve is vertical.
When prices rise however, real wage rates fall, unless their wage rates rise as well.…read more

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Milton Friedman argued that economic agents suffer money illusion but only in the short run. An
increase in AD temporarily increases output above its naturak kevek (Yn), but as soon as
workers realise that higher prices mean lower real wage rates, workers refuse to supply the
labour required for output to remain above Yn.
Alternatively, money wage rates rise and the SRAS supply curve shifts leftward to SRAS2. The
price level then rises to P3.…read more

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