Unit 3- Aggregate Supply

Aggregate Supply(AS): The level of real GDP (GDPᵣ) that firms will produce

Long Run vs. Short Run

Long Run

• The 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

• The period of time where input prices are sticky and don't adjust to changes in the price level.
• In the short-run, the level of real GDP supplied is directly related to the price level.

Two Types of Aggregate Supply

Long-run aggregate supply (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 don't change firms' real profits and therefore don't change firms' level of output. 
• This means that the LRAS is vertical at the economy's level of full employment.

Short Run Aggregate Supply (SRAS)

Happens 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 (SRAS →)
• A decrease in SRAS is seen as a shift to the left (SRAS ←)
• The key to understanding shifts in SRAS is the per-unit cost of production.

                         Per unit production cost = (total input cost)/(total output)

Determinants of SRAS

1. Input/resource prices

• Domestic resource prices
• Wages (75% of all business costs)
• Cost of capital
• Raw materials (commodity prices)

• Foreign resource prices
• Strong dollar (appreciation) = lower foreign resource prices
• Weak dollar (depreciation) = higher foreign resource prices

• Market power
• Monopolies and cartels that control resources and control the price of those resources

Increases in resource prices = SRAS ←

Decreases in resource prices = SRAS→

2. Productivity

• Calculate using (Total output)/(total input)

More productivity = lower unit production cost = SRAS→
Lower productivity = higher unit production cost = SRAS ←

3. Legal Institutional Environment:

• Taxes and subsidies
• Taxes (money the government receives) on businesses increase per-unit production cost = SRAS←
• Subsidies (money the government gives) to businesses reduce per-unit production cost = SRAS→
• Government regulation
• Government regulation creates a cost of compliances = SRAS←
• Deregulation reduces compliance costs = SRAS→