Unit III: Aggregate Supply

Aggregate Supply

-The level of real GDP that firms will produce at each price level (PL)

-Long-run

                                i.            A period of time where input prices are completely flexible and adjust to change in the price level (PL)

                              ii.            in long run the level of real GDP supplied is independent of the PL

-Short run

            i.            A period of time where input prices are sticky and do not adjust to the changes in the price level

          ii.            In the short run real GDP supplied is directly related to the price level

Long Run Aggregate Supply (LRAS)

-Long run aggregate supply marks the level of full employment in the economy (analogous to PPC)

-Because input prices are completely flexible in the long run, changes in the price level do not change firms’ level of output

-LRAS is vertical at the economy’s full employment

Changes in Short Run Aggregate Supply (SRAS)

-Increases in SRAS shifts ->

-Decrease in SRAS shifts <-

-The key unit to understand is SRAS is per unit cost of production

Per unit cost of production= total input cost/total output

Determinants of Short Run Aggregate Supply

I.                    Input prices

                                                                                                  i.            Domestic resources

                                                                                                ii.            Wages (75% of all business cost)

                                                                                              iii.            Cost of capital

                                                                                              iv.            Raw materials

II.                  Foreign resources price

i.                      Strong $= lower foreign resource price

ii.                    Weak $= higher foreign resource price

II.                  Market power

                                                        i.            Increase in resources prices SRAS <-

                                                      ii.            Decrease in resource prices SRAS ->

Productivity

Formula: total output/total inputs

-More productivity= lower unit production cost=SRAS ->

-Lower productivity= higher unit production cost= SRAS <-

Legal Intuitional 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 cost = SRAS ->

Full employment equilibrium is where AD intersects SRAS and LRAS at the same points

(noted as FE, Y*, YF)

Recessionary Gap

-Exist when exists when equilibrium occurs below full employment

 Inflationary Gap

-occurs when equilibrium occurs beyond full employment output