Short-run and long-run aggregate supply, the determinants of each, and the difference between the Keynesian and classical views of the long-run AS curve.

What this dot point is asking

AQA wants you to explain short-run and long-run aggregate supply, the factors that shift each, and the difference between the Keynesian and classical views of the long-run AS curve. The shape of LRAS is one of the most important evaluation points in the whole macro paper.

Short-run aggregate supply

SRAS shifts when costs of production change: wage rates, raw material and energy prices, indirect taxes and subsidies, productivity, and the exchange rate (a weaker pound raises the cost of imported inputs). A leftward shift (higher costs) produces cost-push inflation; a rightward shift (lower costs, for example falling oil prices) lowers the price level and raises output. The oil shocks of the 1970s, which caused stagflation, are the classic applied example of a leftward SRAS shift.

Long-run aggregate supply

LRAS shifts right (capacity grows) with increases in the quantity or quality of factors of production: a larger or more skilled workforce (from immigration, education and training), more capital from net investment, technological progress, the discovery of new resources, and improved efficiency from competition and supply-side reform. This is the same as an outward shift of the production possibility frontier, and it is the only way to raise output sustainably without inflation.

Keynesian versus classical views

The view you adopt shapes your policy conclusions. A classical economist argues that boosting AD when the economy is at capacity simply causes inflation, so growth must come from supply-side policy. A Keynesian argues that when there is a large negative output gap (deep recession, mass unemployment), boosting AD raises real output with little inflation, justifying active fiscal stimulus. In practice the right answer depends on where the economy is relative to its capacity.