Transcript Long run aggregate supply

Aggregate Supply
How is aggregate supply different than supply?
What are the components of AS? Why is this important?
What is the difference between SRAS and LRAS? How are they graphed?
How is the AS curve constructed? What would cause the curve to shift?
Explain why SRAS curve is upward sloping.
Aggregate Supply
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Aggregate supply (AS) measures the volume of goods and services
produced within the economy at a given price level
In other words: amount of real GDP that will be made available by sellers at
various price levels when resource prices (i.e., wages) do not change
– Represents the ability of an economy to deliver goods and services to meet
demand
– Nature of this relationship will differ between the long run and the short run
•
Short run aggregate supply (SRAS) shows total planned output when
prices in the economy can change but the prices and productivity of all
factor inputs e.g. wage rates and the state of technology are held constant.
– In the short run, the SRAS curve is assumed to be upward sloping (i.e. it is
responsive to a change in aggregate demand reflected in a change in the
general price level)
•
Long run aggregate supply (LRAS): LRAS shows total planned output
when both prices and average wage rates can change – it is a measure of a
country’s potential output and the concept is linked to the production
possibility frontier
– In the long run, the LRAS curve is assumed to be vertical (i.e. it does not
change when the general price level changes)
Aggregate Supply Curve
• The aggregate supply curve shows the
relationship between the aggregate price level
and the quantity of aggregate output.
• Aggregate Supply looks different in the Long
Run and the Short Run:
– In the Long Run, classical economists assume the
economy operates at full employment (maximum
output), independent of the price level.
– In the Short Run, businesses will increase supply if
the price level increases.
A change in the price level brought about by a shift in AD results in a movement
along the short run AS curve. If AD rises, we see an expansion of SRAS; if
demand falls we see a contraction of SRAS.
The Short-Run Aggregate Supply Curve
The SRAS is positively sloped
because:
• Auction markets
– Prices are determined by demand and supply
–  prices   profits   quantity supplied
• Posted-price markets
– Prices are set by producers and don’t often
change
– Firms respond to changes in demand by
adjusting output instead of prices
Sticky Nominal Wages
• The short-run aggregate supply curve is upward-sloping because
nominal wages (dollar amount of the wage paid) are “sticky” in the
short run:
– Sticky: a variable is resistant to change
– a higher aggregate price level leads to higher profits and
increased aggregate output in the short run.
– Market forces may reduce the real value of labor in an industry,
but wages will tend to remain at previous levels in the short run.
– Can be due to institutional factors:
• price regulations
• legal contractual commitments
• labor unions
• human stubbornness, human needs, or self-interest
• Stickiness may apply in one direction. For example, a variable that is
"sticky downward" will be reluctant to drop even if conditions dictate
that it should. However, in the long run it will drop to the equilibrium
level.
Movement vs. Shift
• A change in aggregate price levels causes a movement
along the SRAS curve.
• However, a shift in SRAS is caused by changes in costs
of production:
– commodity prices (“non-labor resource prices”)
• Expectations surrounding future inflation
• Increase in import prices
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nominal wages
business taxes (taxes on firms’ profits)
subsidies offered to businesses
supply shocks—events that have a sudden, strong impact on
SRAS (weather, war…)
• lead to changes in producers’ profits and shift the shortrun aggregate supply curve
Shift in SRAS
LEFT
• Increase in wages (if
price level constant)
• Increase in price of
non-labor resources
• Decrease in subsidies
• Unfavorable
conditions (weather,
conflict)
RIGHT
• Wages decrease
(price level constant)
• Decrease in price of
non-labor resources
• Increase in subsidies
• Favorable conditions
(weather)
The main cause of a shift in the supply curve is a change in business costs.
From the Short Run to the Long Run
Leftward Shift of the Short-run Aggregate Supply Curve
From the Short Run to the Long Run
Rightward Shift of the Short-run Aggregate Supply Curve
Long-Run Aggregate Supply
(LRAS), part I
“Seemingly small differences in growth rates can have a
large impact over a period of many years. For example, if an
economy grew by 2 per cent every year, it would double in
size within 35 years; if it grew at 2½ per cent a year, it would
double in size after 28 years - seven years earlier”
Source: UK Treasury
LRAS
• The long-run aggregate supply curve shows the relationship
between the aggregate price level and the quantity of aggregate
output supplied that would exist if all prices, including nominal
wages, were fully flexible
– LRAS is determined by the stock of a country’s resources and by the
productivity of factor inputs (labour, land and capital). Changes in the
technology also affect potential real national output.
• In the long run, the ability of an economy to produce goods and
services to meet demand is based on the state of production
technology and the availability and quality of factor inputs.
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A long run production function for a country is often written as follows:
Y*t = (Lt, Kt, Mt)
Y* is a measure of potential output
t is the time period
L represents the quantity and ability of labor input available
Kt represents the available capital stock
Mt represents the availability of natural resources
A Range for Potential Output
and the LAS Curve
• The position of the long-run aggregate
supply curve is determined by potential
output– the amount of goods and services
an economy can produce when both labor
and capital are fully employed.
• There are two models for LRAS:
– Monetarist (new classical)
– Keynesian
Monetarist view of LRAS
• Key principles:
– Importance of the price
mechanism in coordinating
economic activities
– Competitive market
equilibrium
– Economy is harmonious
system that automatically
tends towards full
employment
• These are all points of
contention in
macroeconomics
• Shape of LRAS!
• Shown as vertical at
potential GDP, or full
employment level of GDP
(YP)
• Means that in the longrun, a change in the price
level does not result in
any change in the
quantity of real GDP
produced
Long-Run Aggregate Supply Curve
Monetarist view of LRAS, cont.
• The economy is in
long-run equilibrium
when the AD curve
and the SRAS curve
intersect at any point
on the LRAS curve
• p. 245, 248 in your
home text
• p. 234, 237
Long-Run Aggregate Supply Curve
Real GDP = $6 trillion
at every point on LRAS.
• LRAS is vertical line at full
employment level of GDP
(regardless of price level).
WHY?!
• In the monetarist view, gaps
are eliminated in the LR by
flexibility in resource prices.
This ensures that the LRAS
curve will be vertical at the
level of potential GDP. The
economy then has a built-in
tendency towards fullemployment equilibrium.
Changes in AD can have an
influence on real GDP only in the
short run; in the long run, it only
results in changing the price level,
having no impact on real GDP
(remains constant at level of
potential output). So, increases in
AD in long run are inflationary.
Shifts in LRAS
A shift in LRAS is caused by changes in any (ceteris paribus) factor other than
the price level, such as natural rate of growth of output.
LRAS curve can either shift rightward (increase in AS/real GDP/pos. econ.
growth) or leftward (decrease in AS/real GDP/neg. econ. growth).
Resource Quantity: the quantity of
the resources--labor, capital, land,
and entrepreneurship--that the
economy has available for
production.
– include population growth, labor
force participation, capital
investment, and exploration.
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If the economy has more
resources, more efficient: AS
increases and LRAS curve shifts
rightward.
If the economy has fewer
resources, less efficient: AS
decreases and LRAS curve shifts
leftward.
Resource Quality: quality of
resources, especially technology
and education.
– labor, capital, land, and
entrepreneurship
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Improved quality or reduction in
unemployment increases AS,
triggering a rightward shift of the
LRAS curve
Decline in quality or increase in
unemployment decreases AS,
generating a leftward shift of the
LRAS curve
Any change in the economy that alters the natural rate of growth of output
shifts LRAS. Improvements in productivity and efficiency or an increase in
the stock of capital and labor resources cause the LRAS curve to shift out.
Economic Growth Shifts the LRAS
Curve Rightward
LAS
LAS1
• The LAS curve shows the longrun relationship between output
and the price level.
• The position of the LAS curve
Price Level
depends on potential output –
the amount of goods and
services an economy can
produce when both capital and
labor are fully employed.
• The LAS is vertical because
potential output is unaffected
by the price level.
• Economic
Potential
output
Real
output
growth shifts the
LRAS to the right.
How are SRAS and LRAS related?
• Econ growth=LRAS shifts right, signaling increase in potential
output. However, SRAS curve will shift right because at any
moment in time, economy is always producing on an SRAS curve.
• Any factor that shifts the LRAS curve must also shift SRAS
curve.
– SRAS can be shifted temporarily from LRAS, such as
unfavorable conditions. Changes in wages, or prices of key
inputs (i.e., oil) may only affect SRAS curve. This applies only to
changes that don’t have a lasting impact on GDP.
TRY IT!
• Rising investment shifts the aggregate demand
curve to the right and at the same time shifts the
long-run aggregate supply curve to the right by
increasing the nation’s stock of physical and
human capital.
• Show this simultaneous shifting in the two
curves with three graphs.
– One graph should show growth in which the price
level rises,
– one graph should show growth in which the price
level remains unchanged,
– and another should show growth with the price level
falling.
TRY IT! answers
• Panel (a) shows AD shifting by more than LRAS; the price level will
rise in the long run.
• Panel (b) shows AD and LRAS shifting by equal amounts; the price
level will remain unchanged in the long run.
• Panel (c) shows LRAS shifting by more than AD; the price level falls
in the long run.
The Following Slides
are from your textbook.
Actual and Potential Output
LAS Curve
LAS
• Estimating potential output is
inexact, so it is assumed to be the
middle of a range bounded by a
high level of potential output and a
low level of potential output.
C
• The relationship between
Price Level
B
A
potential and actual output – where
the economy is on SAS – determines
shifts in SAS.
SAS
• When resources are over-utilized
Underutilized
resources
(point C), factor prices may be bid
up and the SAS shifts up.
Overutilized
resources
• When resources are under-utilized
Lowlevel
potential
output
High-level
potential
output
Real
output
(point A), factor prices may decrease
and SAS shifts down.
• When LAS = SAS (point B), there is
no pressure for prices to rise or fall.
Long-Run Macroeconomic
Equilibrium
LR equilibrium of
$6 trillion in real GDP
and price level of 100.
Supply Creates Its Own Demand!
Short-Run Aggregate Supply Curve
• SRAS is relatively flat at low levels of output,
and gradually approaches vertical.
Beyond full employment GDP,
expanding production is more
expensive, so firms need large
price increase output.
At low levels of output, firms
can easily expand output when
prices rise.