Macroeconomics Unit III: Aggregate Supply

AGGREGATE SUPPLY

• the level of real GDP that firms will produce at each price level.

Long Run (LRAS)

• period of time where input prices are completely flexible and adjust to changes in the price level.
• level of real GDP supplied is independent of the price level
• marks the level of full employment in the economy 
• analogous to PPC
• because input prices are completely flexible, changes in price level do not change a firm's real profits, therefore do not change a firm's level of output
• LRAS is vertical at economy level of full employment
• vertical line at an output level that represents the quantity of goods and services a nation can produce over a sustained period using all of productive resources as efficiently as possible with all current technology available to it. 

Short Run (SRAS)

• period of time where input prices are sticky and do not adjust to the changes in price level
• the level of real GDP supplied is directly related to the price level
• because input prices are sticky, SRAS is upward sloping
• an increase in SRAS: shift to the right
• a decrease in SRAS: shift to the left
• key to understanding shifts is per unit cost of production
• per unit cost of production: (total input cost)/ (total output cost)

LRAS

• stable at full employment 
• does not change as price level changes

LRAS Curve

• represents a point on economy PPC
• shifting outward with PPC
• change in resources, technology, economic growth

DETERMINANTS OF SRAS

• input prices
• productivity
• legal- institutional environment

Input Prices

1. Domestic Resource Power
2. Wages (75% business cost)
3. Cost of Capital
4. Raw Materials (commodity prices)
5. Foreign Resource Power

• strong money: lower foreign resource power
• weak money: higher foreign resource power

     6.  Market Power

• monopolies and cartels that control prices of those resources
• increase in resource prices: SRAS  ←
• decrease in resource prices: SRAS →

Productivity 

• (total output)/ (total input)
• more productivity: lower unit production cost: SRAS →
• less productivity : higher unit production cost : SRAS ←

Legal- Institutional Environment

1. Taxes and Subsidies

• taxes on business (money to government) SRAS ←
• subsidies (money from government) to business reduce per unit production: SRAS →

      2.  Government Regulation

• creates cost of compliance: SRAS ←
• deregulation reduces compliance costs: SRAS →