Unit 3: Aggregate Supply

March 6, 2018

Aggregate Supply

• The level of supply of Real GDP (GDPR) that firms will produce at each Price Level (PL).

Long-Run vs. Short-Run

• Long-Run: Period of time where input prices are completely flexible and adjust to changes in the price level.
• The level of Real GDP supplied is independent of the price-level.
• Short-Run: Period of time where input prices are sticky do not adjust to changes in the price level.
• The level of Real GDP supplied is directly related to the price-level.
• Long Run Aggregate Supply (LRAS): marks the level of full employment in the economy. (analogous to PPC)

Full Employment of graph: FE, Yf, Y*

• Short Run Aggregate Supply (SRAS): Because input prices are stick in the short run, the SRAS is upward sloping.

Changes in SRAS

• An increase in SRAS is seen as a shift to the right. SRAS→
• A decrease in SRAS is seen as a shift to the left. SRAS←
• The key to understanding shifts in SRAS is per unit cost of production.

Per-unit Production Cost = (total input cost)/(total output)

Determinates of SRAS (all of the following affect unit-production cost):

• Input prices
• Domestic Resource Prices
• Wages (75% of all business costs)
• Cost of capital
• Raw Materials (commodity prices)
• Foreign Resource Prices
• Strong $ = lower foreign resource prices
• Weak $ = higher foreign resource prices
• Market Power
• Monopolies and cartels that control resource control the price of those resources.
• Increases in Resource Prices = SRAS←
• Decrease in Resource Prices = SRAS→
• Productivity
• Productivity = (total output)/(total input)
• More productivity = lower unit production cost = SRAS→
• Lower Productivity = higher unit production cost = SRAS←
• Legal-Institutional Environment
• Taxes and subsidies
• Taxes ($ to government on business increase per unit production cost = SRAS←
• Subsidies ($ from government) to business reduce per unit production cost = SRAS→
• Government Regulation
• Government regulation creates a cost of compliance = SRAS←
• Deregulation reduces compliance costs = SRAS→