Unit 3 - Aggregate Supply (2-18-16)

Aggregate Supply: the level of real GDP that firms will produce at each price level

Long-Run vs. Short-Run

Long:

• 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 price-level

Short:

• Period of time where input prices are sticky and do not adjust to changes in the price-level (hard to shift)
• In short-run, level of REAL GDP supplied is directly related to price level

Long Run Aggregate Supply (LRAS):

• LRAS marks the level of full employment in the economy. (analogous to PPC)
• Because input prices are completely flexible in the long-run, changes in price-level do not change firms' real profits and therefore do not change firms' level of output. This means that the LRAS is vertical at the economy's level of full employment

Changes in Short-Run Aggregate Supply (SRAS):

• An INCREASE in SRAS in seen as a shift to the RIGHT --->
• A DECREASE in SRAS is seen as a shift to the left <---

SRAS is per unit cost of production.
Per Unit Production Cost = (Total Input Cost / Total Output)

Determinants of SRAS 

• Input prices
• Productivity
• Legal-Institutional Environment

Input:

1) Domestic Resource Prices

• Wages (75% of all business costs)
• Cost of capital
• Raw Materials (commodity prices)

2) Foreign Resource Prices
3) Market Power
4) Increase in Resource Prices = SRAS <---
5) Decreases in Resource Prices = SRAS --->

Productivity:

= (Total Output / Total Input )

• more productivity = lower unit production cost = SRAS --->
• lower productivity = higher unit production cost = SRAS <---

Legal Institutional Environment:

Taxes & Subsidies

• Taxes ($ to Gov.) on business increase per unit production cost = SRAS <---
• Subsidies ($ from Gov.) to business reduce per unit production cost = SRAS-->