Aggregate Supply

2-18-16

Aggregate Supply- the level of Real GDP (GDPr) that firms will produce at each Price Level(PL)

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

Versus

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

Graphs on Vanilla Paper

-The Long -Run Aggregate Supply or 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.

*Example is Graph #3 on Vanilla paper

Changes in Short Run Aggregate Supply (SRAS)

- Increase in the SRAS is seen as a shift to the right

- Decrease in the SRAS is seen as a shift to the left

-The key to understanding shifts in the SRAS is per unit cost of production

-Per-Unit Production Cost= Total Input Cost/Total Output

Determinants of SRAS

- Input Prices:

A. Domestic Resource Prices 1. Wages(75%) , 2. Cost of Capital , 3. Raw Materials
B. Foreign Resource Prices
C. Market Power

Increases in Resource Prices = Shift to the Left

Decrease in Resource Prices = Shift to the Right

- Productivity

Productivity= Total Output/Total Inputs

More Productivity = Lower Unit Production Cost = SRAS shift to the right

Lower Productivity = Higher Unit Production Cost = SRAS shift to the left

- Legal Institutional Environment

Taxes and Subsidies

1. Taxes ($ to the government) on business increase per unit production cost = SRAS shifts to the Left
2. Subsidies ($ from the government) to business reduce per unit production cost = SRAS shifts to the RIght

Government Regulation

1. Government regulation creates a cost of compliance = SRAS Left
2. Deregulation reduces compliance costs = SRAS Right