Unit 3- Topic 2: Aggregate Supply

Aggregate Supply- The level of Real GDP that firms will produce at each price-level.

Long-Run v. Short-Run

Long-Run 

• Period of time where input prices are completely flexible and adjust to change in the price-level.
• In the long-run, the level of Real GDP supplied is independent of the price-level
• Vertical

Short-Run

• Period of time where input prices are STICKY and do not adjust to changes in price-level.
• In the short-run, the level of Real GDP supplied is directly related to the price-level.

Long-Run Aggregate Supply (LRAS)

• Always located with full employment 
• The Long-Run Aggregate Supply marks the level of full employment in the economy. 
• Analogous to PPC

Short-Run Aggregate Supply (SRAS)

• Because input prices are sticky in the short-run, the SRAS is upward sloping.

Changes in SRAS

• Increase: SRAS →
• Decrease: SRAS ←
• The key to understanding shifts in SRAS is per unit cost of production.
• Per Unit Production Cost Formula: (Total Input Cost/Total Output Cost)

Determinants of SRAS

1. Input Prices
2. Productivity
3. Legal- Institutional Environment

1) Input Prices

Domestic Resource Prices

• Wages (75% of all business costs)
• Cost of captial
• Raw materials (commodity prices)

Foreign Resources Prices

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

Market Power

• Monopolies and cartel that control resources control the price of those resources

Increase in resource prices= SRAS ←

Decrease in resource prices= SRAS →

2) Productivity

Productivity= (Total Output/ Total Input)

• Most productivity= lower unit production cost= SRAS →
• Lower productivity= higher unit production cost= SRAS ←

3) Legal- Institutional Environment 

Taxes and Subsidies

• Taxes ($ to gov't) on business increase per unit production cost = SRAS ←
• Subsidies ($ from gov't) to business reduce per unit production cost= SRAS→

Government Regulation

• Government Regulation creates a cost of compliance = SRAS ←
• Deregulation (lift up rules and regulation, set your own price) - Reduces compliance costs= SRAS →