Edexcel IAL Economics: Aggregate supply, circular flow, equilibrium (YEC11) – Revision Notes

These notes condense sections 2.3.3 and 2.3.4 items 1 to 3 of the Pearson Edexcel International Advanced Subsidiary/Advanced Level Economics specification (YEC11), Issue 2, June 2018. The specification places this content in Unit 2, one of the two International AS (IAS) units, so it also counts towards the full International Advanced Level. For explanations and fuller examples, read the study guide, then test yourself on the practice set.

Other links: course hub, printable checklist and the free diagnostics. The multiplier is covered in a separate unit. All figures here are invented.

Definitions to learn word for word

Term	Definition
Aggregate supply (AS)	Planned real output of all firms combined at each general price level
SRAS	AS in the period when at least one factor, usually capital, is fixed
LRAS	The economy’s productive capacity when all factors can change
Movement along AS	Caused only by a change in the price level
Shift of AS	Caused by a change in costs or capacity at every price level
Circular flow	Income, output and expenditure moving between households and firms
Income	A flow: amount received per period
Wealth	A stock: value of assets owned at a point in time
Injection	Spending that enters the circular flow: I, G, X
Withdrawal	Income that leaves the flow: S, T, M
Equilibrium real output	Real output where AD = AS

2.3.3 Aggregate supply

Movement or shift?

Price level changes        -> movement along the AS curve
Costs or capacity change   -> AS curve shifts
Costs fall / capacity up   -> shift right
Costs rise / capacity down -> shift left

SRAS factors (2.3.3 item 2)

Factor	Direction	Chain of reasoning
Dearer raw materials or energy	SRAS left	unit costs rise, profit per unit falls, less supplied at each price
Exchange rate falls	SRAS left	imported inputs cost more in home currency
Exchange rate rises	SRAS right	imported inputs cost less
Higher tax on firms (for example on employing labour)	SRAS left	costs rise
Lower tax on firms	SRAS right	costs fall

Small worked reminder. A firm imports an input priced at 30 foreign units. At 0.60 foreign units per home unit it costs 30 ÷ 0.60 = 50 home units. At 0.50 it costs 60, a 20% rise. A smaller employer tax: 10 staff on 500 each (wage bill 5,000) at 8% costs 400; at 5% it costs 250. The saving is 150 a week.

LRAS (2.3.3 item 3)

Feature	Classical	Keynesian
Shape	Vertical at full employment	Horizontal, then upward sloping, then vertical
AD rise	Raises prices only	Output only, then both, then prices only
Key belief	Output set by supply-side resources	Spare capacity can exist, so output depends on AD

LRAS shifts right when any of these improve:

• state of technology
• productivity
• education and skills
• government regulations and tax (lighter, better designed rules)
• demography and net migration (bigger or more skilled labour force)
• competition policy (more rivalry, lower costs, more innovation)

Method in steps for an LRAS factor question:

1. Name the factor and say what changes (for example, skills).
2. Say what that does to productive capacity.
3. State the shift (LRAS right).
4. Add a side effect (at unchanged AD, price level falls and output rises) or an evaluation point (it takes time).

Worked reminder. 18 million workers produce 450 billion, so output per worker is 25,000. If productivity rises 4% to 26,000 and employment stays the same, output = 18m × 26,000 = 468 billion.

2.3.4 The circular flow

• Basic flow: households give factor services and receive income; firms give goods and services and receive spending.
• Withdrawals: saving, taxation, imports.
• Injections: investment, government expenditure, exports.
• J > W: net injection, output tends to rise.
• W > J: net withdrawal, output tends to fall.
• J = W: flow stable.

Small worked reminder. S = 50, T = 70, M = 40 so W = 160. I = 60, G = 80, X = 30 so J = 170. Net injection = +10, so output tends to rise.

Income versus wealth: a household earning 24,000 a year with 60,000 of assets that saves 2,400 has wealth of 62,400 (prices unchanged). Saving is the link between the flow and the stock.

Equilibrium real output (2.3.4 item 3)

Shift	Output	Prices
AD right	up	up
AD left	down	down
SRAS right	up	down
SRAS left	down	up
LRAS right	up (capacity)	down, at unchanged AD

Worked reminder (invented). AD: output = 900 − 2P. SRAS: output = 500 + 2P.

900 − 2P = 500 + 2P  so 4P = 400, P = 100, output = 700.
Costs rise, SRAS = 460 + 2P: 4P = 440, P = 110, output = 680.
Price +10%, output −2.9% (680/700 − 1).
AD rises by 60 (960 − 2P): 4P = 460, P = 115, output = 730.

If LRAS is classical at 700, the same AD gives a long-run price level of (900 − 700) ÷ 2 = 100.

Diagrams you should be able to draw

1. AD/AS with a cost shock. Axes: price level (vertical) and real national output (horizontal). Draw a downward-sloping AD curve and an upward-sloping SRAS curve meeting at equilibrium (P1, Y1). Shift SRAS to the left to SRAS2. The new equilibrium (P2, Y2) has a higher price level and lower output. Label every curve and both equilibrium points.
2. Classical LRAS. A vertical line at full-employment output. Shift AD right: the price level rises, output stays at the vertical line.
3. Keynesian LRAS. Horizontal section, upward-sloping section, vertical section. Show one AD shift in each section and state the output and price effect.
4. LRAS shift. Move the vertical line to the right. With AD unchanged, the equilibrium price level falls and output rises.
5. Circular flow. Households and firms, with income flowing to households and spending flowing to firms. Leakages (S, T, M) drawn leaving, injections (I, G, X) drawn entering.

Keep any diagram you draw tied to the sentence that explains it. A diagram with no explanation is weaker than the same diagram backed by a clear chain of reasoning.

Keynesian shape: quick numerical reminder

Invented curve: price level 80 up to output 500; then price = 80 + 0.25 × (output − 500) up to output 900; then vertical.

AD moves output from	to	Price level	Output change	Price change
420	480	80 to 80	+14.3%	0%
700	800	130 to 155	+14.3%	+19.2%

Output rises by the same 14.3% in both rows, but the price effect differs. Say why: spare capacity in the first range, bottlenecks in the second.

Evaluation prompts

• Time. SRAS shifts are often temporary (energy price spikes can reverse); LRAS shifts take years (education, technology).
• Size and scope. A small tax change on one sector may not shift the whole curve.
• Spare capacity. Whether extra AD raises output depends on where the economy sits.
• Offsetting changes. A depreciation raises import costs (SRAS left) but may also raise export demand (AD right).
• Reliability of data. Estimates of full-employment output are uncertain.
• Distribution. More output is not the same as more welfare for everyone.

Build a judgement with “it depends on…”, then say which condition is most likely for the economy described, and why.

Must-know distinctions

• Movement along AS versus shift of AS.
• SRAS (costs) versus LRAS (capacity).
• Classical (vertical) versus Keynesian (three sections).
• Income (flow) versus wealth (stock).
• Injection versus withdrawal.
• Equilibrium in the short run versus the long run.

Quick self-test

1. Name one change that shifts SRAS right.
2. An input costs 30 foreign units. The rate moves from 0.60 to 0.50 foreign units per home unit. What happens to the home-currency cost?
3. State two differences between classical and Keynesian LRAS.
4. Why does a rise in net migration shift LRAS?
5. Distinguish income from wealth.
6. List the three withdrawals.
7. With S = 50, T = 70, M = 40, I = 60, G = 80, X = 30, is there a net injection or withdrawal?
8. 18 million workers each produce 26,000. What is output?
9. AD: output = 900 − 2P; SRAS: output = 460 + 2P. Find equilibrium.
10. What happens to output and prices if SRAS shifts left with AD unchanged?

Answers

1. Lower energy costs, a stronger exchange rate or lower business taxes (any one).
2. Rises from 50 to 60, up 20%.
3. Classical is vertical; Keynesian has spare-capacity and capacity sections. Under classical, AD only changes prices; under Keynesian, AD can change output.
4. More workers raise the labour force and capacity.
5. Income is a flow per period; wealth is a stock of assets at a point in time.
6. Saving, taxation, imports.
7. Net injection of 10 (J = 170, W = 160).
8. 18m × 26,000 = 468 billion.
9. P = 110, output = 680.
10. Output falls, prices rise.

Where marks are usually lost

• Writing that a higher price level shifts AS.
• Using “supply” when the question asks about aggregate supply.
• Giving a factor without a chain of reasoning to costs or capacity.
• Listing education and skills as a shift of SRAS rather than LRAS.
• Counting saving or taxation as an injection.
• Ignoring the base when giving a percentage.
• Drawing a diagram and not labelling axes, curves and equilibrium points.
• Writing “output rises” without saying whether that is real output.

Official syllabus

Pearson Edexcel International Advanced Subsidiary/Advanced Level in Economics (YEC11), Specification, Issue 2, June 2018, Pearson Education Limited: Unit 2, sections 2.3.3 and 2.3.4.