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Elasticity of AS


In contrast to the Monetarist view of the SRAS and LRAS, Keynesians believe the extent to which the economy as a whole can supply extra output of goods and services following a rise in aggregate demand is determined by the elasticity of the aggregate supply curve. Remember that elasticity is a measure of responsiveness - in other words, how easy it is for firms to respond to higher demand by utilising existing factor resources more efficiently or intensively, or by bringing unused factors (spare land, labour and capital) into the production process.


The elasticity of the aggregate supply curve will depend on where the economy is in the economic cycle and critically the available of spare factor resources (or spare capacity)



When the economy is operating at a low level of national output, there is a large stock of unused factor inputs. Unemployment in the labour market is likely to be high and there are many factories operating well below their productive capacity. In this situation, aggregate supply will be elastic. A change in aggregate demand can be met without any substantial upward pressure on costs and prices. This is shown in the diagram below



However if the economy is approaching full-employment, the amount of spare capacity available to raise output will have fallen. Supply-bottlenecks are likely to emerge as businesses compete with each other for the remaining labour and capital resources.


In this situation the AS curve becomes inelastic. Indeed there may come a point when aggregate supply is perfectly inelastic (vertical). If aggregate demand increases the prices of goods and services will rise and real output will remain unchanged. This is shown in the diagram overleaf.



Increases in aggregate demand shown in the diagram simply cause an increase in the general price level (i.e. inflation). The likely response of economic policy-makers would be an attempt to reduce aggregate demand through deflationary fiscal or monetary policy measures.





E-mail Steve Margetts