Unit 3 Aggregate Supply

Aggregate Supply

• The level of Real GDP (GDPr) that firms will produce at each price level. 

Long Run v. 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 independently related to the price level. 
• The Long-run aggregate supply or LRAS marks the level of full employment in the conomy

Short

• 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 indirectly related to the price level.
• In the Short-Run because input prices are sticky 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 shifts in SRAS is per unit cost of production 

Per-Unit Cost of Production 

• Total Input/Total Output 

SRAS Determinants

• Input Prices 
• Productivity
• Legal Institutional Environment 

Input Prices 

• Domestic Resources Prices (Wages: 75% of all businesses) 
• Cost of Capital 
• Raw Materials (Commodity Prices) 
• Foreign Resource Prices 
• (Strong Economy= Lower Foreign Resources Prices)
• (Weak Economy=Higher Foreign Resource Prices)

Market Power

• Monopolies and Cartels that control resources control the prices of those resources

Increases in Resource Prices= SRAS <-----

Decreases in Resource Prices= SRAS------>

Productivity= Total Output/Total Input 

• More Productivity= Lower Production Cost (SRAS ------->)
• Lower Productivity= Higher Unit Production Cost= (SRAS<------)

Legal Institutional Environment 

• Taxes and Subsidies
• Taxes ($ to government) on business increase per unit production cost=SRAS<----
• Subsidies ($ from government) to business reduce per unit production cost= SRAS--->
• Government Regulation
• Government Regulation creates a cost of compliance (SRAS <---)
• Deregulation
• Reduces compliance cost= SRAS--->