Question

What influences the LRAS (long run aggregate supply) and SRAS (short run aggregate supply)?

What are the three theories that explain the upward slope of the SRAS?

How do both monetary and fiscal policy affect the AD?

Answer 1

Actually “SRAS” show the total production of an economy as a whole at each price level. So, it shows the positive relationship between “Price” and “output”. Now, the “SRAS” will change because of the following factors.

1). If input price will change that will change the production cost, => “SRAS” will change it’s position. So, if the “input price” increases implied “SRAS” will shift to left side and vice versa.

2). It the expected price change that will change the position of the “SRAS”. So, if the expected price increases, => the “SRAS” will shift to left side and vice versa.

3). Technological improvement will reduce the production cost by increasing the “marginal productivity of inputs”, => same level of output can be produced at must lower cost, => “Technological improvement” leads to right side shift of “SRAS”.

Now, in the LR the “expected price” can’t be differ from the “actual price”, => in the LR “P=Pe”, => the “LRAS” is vertical at its natural level. So, the “LRAS” shows the potential level of output that can economy can produce given the “technology” and the “input availability”. So, the “LRAS” will shift because of “technological improvement” and because of the change in the input supply.

c).

Now, the “AD” shows the negative relationship between “P” and “Y”. It shows the aggregate demand at each “P”. Now, expansionary fiscal and monetary policy will lead to right side shift of the “AD”.

Now, the expansionary implied “increase of G” or “decrease of T”, => in both the cases the demand for goods and services increases, => the equilibrium “Y” as well as “Y” will increase in “IS-LM model” at the given price, => the “AD” will shift right side. Similarly, an expansionary monetary policy will increase the money supply that will increase the equilibrium “Y” through increase in “investment” and decrease the interest rate at the given price level, => “AD” will shift right side.

So, expansionary fiscal and monetary policy both leads to right side shift of the “AD” and vice versa.