Aggregate Supply

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AGGREGATE SUPPLY
  • The level of Real GDP 




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Long Run v. Short Run
  • Long Run
    • Period of time where input prices are completely flexible and adjust to changes in the price level.
    • In the long run, the level of Real GDP supplied is independent of the price level.
  • Short Run
    • Period of time where input prices are sticky and do not adjust to changes in the price level.
    • In the short run, the level of Real GDP supplied is directly related to the price level.
LONG RUN AGGREGATE SUPPLY (LRAS)
  • The Long Run Aggregate Supply or LRAS marks the level of full employment in the economy (This is similar to that of PPC)
SHORT RUN AGGREGATE SUPPLY (SRAS)
  • Because input prices are sticky in the short run, the SRAS is upward sloping. 
Changes in SRAS
  • An increase in SRAS is seen as a shift to the right. 
  • A decrease in SRAS is seen as a shift to the left. 
  • The key to understanding shifts in SRAS is per unit cost of production.
  • Formula: Per-unit production cost = total input cost/total output
DETERMINANTS OF SRAS (all of the following affect unit production cost)
  • Input Prices
    • Domestic Resource Prices
      • Wages (75% of 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 resources control the price of those resources.
      • Increases in Resource Prices = SRAS shifts to the left
      • Decreases in Resource Prices = SRAS shifts to the right
  • Productivity
    • Productivity = total outputs/total inputs
    • More productivity = lower unit production cost = SRAS shifts to the right
    • Lower Productivity = higher unit production cost = SRAS shifts to the left
  • Legal Institutional Environment
    • Taxes and Subsidies
      • Taxes ($ to govt) on business increase per unit production cost = SRAS shifts to the left
      • Subsidies ($ from govt) to business reduce per unit production cost = SRAS shifts to the right
    • Government Regulation
      • Government regulation creates a cost of compliance = SRAS shifts to the left
      • Deregulation reduces compliance cost = SRAS shifts to the right

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