Unit 3 - Aggregate supply

February 12, 2015

The aggregate supply curve depicts the quantity of real GDP that is supplied by the economy at different price levels.

Long Run vs Short Run

• 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.
• 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.

Long Rund 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 do not change firm's real profits and therefore do not change firms level of output. Meaning that LRAS is vertical at the economy's level of full employment.

Short Run Aggregate Supply (SRAS) Because input prices are sticky in the short-run, the SRAS is upward sloping.

An increase in SRAS is seen as a shift to the right. A decrease in SRAS is seen as a shift to the left
The key to understanding shift in SRAS is per unit cost if production
Per unit production cost= total input cost/total output

Determinant of SRAS

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

Foreign resource prices

• Strong $ = lower foreign resource prices
• Weak $ = higher foreign resource prices

Market power-monopolies and cartels that control rss control the price if those rss

• Increase In resource prices (AS Shift <)
• Decreases In resource prices (AS Shift >)

Productivity

• productivity = total output/ total inputs
• More productivity= lower unit production cost (AS Shift >)
• Lower productivity = higher unit production cost (AS Shift <)

Legal institutions environment (Taxes and subsides)

• taxes ($ to government) on business increase per unit production cost (AS Shift <)
• subsidies ($ from government) to business reduce pet unit production cost (AS Shift >)

Government regulation

• Government regulation created a cost of compliance (AS Shift <)
• Government deregulation reduces compliance costs (AS Shift >)