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.
|