Unit 3: Aggregate Supply

Aggregate supply:

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

Long run V 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 run Aggregate supply (LRAS)

• The long run aggregate supply or LRAS 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. 

▲in Short run SRAS:

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

Determinant of SRAS (AFFECT UNIT PRODUCTION COST)

• Input prices
• Domestic resource prices
• Wages (75% of all business costs)
• 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 resources control the price of those resources 
• Increase in resource prices =SRAS (left)
• Decrease In resource prices = SRAS (right)
• Productivity
• Productivity=total output/total input
• More productivity= lower unit production cost= SRAS(right)
• Lower productivity = higher until productivity cost=SRAS(left)

Legal institutional environment

• Taxes and subsidies
• Taxes ($ to govt) on business increase per unit production cost= SRAS to the left
• Subsidies ($ from govt) to business reduce per unit production cost= SRAS to the right
• Government regulation
• Government regulation creates a cost of compliance = SRAS to the left 
•  Deregulation reduces compliance costs = SRAS to the right