Transcript Aggregate Supply in the Short and Long Run

Aggregate Supply in the
Short and Long Run
Aggregate Supply
• Aggregate supply measures total
production within our economy
– It is determined by current price levels
and three factors of production
• Input prices, productivity levels (input vs
output) and legal-institutional factors (taxes
and government regulations)
AGGREGATE SUPPLY IN THE
SHORT AND LONG-RUN
Short Run Period in which nominal wages
(and other input prices) remain
fixed as the price level increases
or decreases
Long Run Period in which nominal wages
are fully responsive to previous
changes in the price level
SHORT-RUN AGGREGATE SUPPLY
A higher price level increases profits and
output moving the economy from a1 to a2
AS1
Price Level
P2
P1
o
a2
a1
Q1
Q2
Real domestic output
SHORT-RUN AGGREGATE SUPPLY
A lower price level decreases profits and
output moving the economy from a1 to a3
AS1
Price Level
P2
a2
P1
P3
o
a1
a3
Q3
Q1
Q2
Real domestic output
SHORT RUN AGGREGATE
SUPPLY
• There are three reasons why the Short run Aggregate
Supply curve is upward sloping.
• Sticky wages - as prices rise wages may be slow to
follow, allowing business owners to profit from higher
prices.
• Sticky prices- all prices do not rise simultaneously. A
business that is slow to raise their prices may sell more
in the short run.
• Misperceptions of price increases – a business owner
may assume incorrectly that the increase in price level is
the result of an increase in demand for THEIR product
and therefore increase production.
Why the Short-run Aggregate
Supply Curve Might Shift
Shifts arising from a change in Labor costs.
Shifts arising from a change in Capital costs.
Shifts arising from a change in Natural Resource
costs.
Shifts arising from a change in Technology.
Shifts arising from a change in the Expected
Price Level.
Shifts Arising from a Change in
Expected Price Level
When people expect an increase in price
levels they tend to set wages high. This
shifts the short-run aggregate supply curve to
the left.
When people expect a decrease in price
levels the tend to set wages low. This shifts
the short-run aggregate supply curve to the
right.
The Aggregate Supply Curve
In the short run, the aggregate-supply
curve is upward sloping.
In the long run, the aggregate-supply
curve is vertical.
The long-run curve is derived from the
shifts of the short-run curve that happen
in the long-run.
The long-run is the period of time when
wages (and other input costs) catch up
with prices.
LONG RUN AGGREGATE SUPPLY
A higher price level results in higher nominal wages and thus shifts
the short-run aggregate supply to the left. The result is higher prices,
but a return to the original level of output.
AS2
Price Level
P2
P1
o
b1
AS1
a2
a1
Q1
Q2
Real domestic output
LONG RUN AGGREGATE SUPPLY
A lower price level reduces nominal wages and shifts the short-run
aggregate supply to the right. This results in lower prices, but a return
to the original level of output.
ASLR
b1
Price Level
P2
AS2
AS1
a2
AS3
a1
P1
P3
o
a3
Q3
c1
Q1
Q2
Real domestic output
The Long Run
Aggregate Supply Curve
• The Long run AS curve represents the economy
at its full employment/natural rate of
unemployment level.
• It is the level of output that an economy can
produce if all of its resources are fully employed.
• An equilibrium point to the left of the LRAS
indicates we are below full employment. An
equilibrium point to the right of the LRAS
indicates that we are beyond full employment.
The Long-Run Aggregate- Supply
Curve...
Price
Level
P1
Long-run
aggregate
supply
2. …does not
affect the quantity
of goods and
services supplied
in the long run.
P2
1. A change
in the price
level…
0
Natural rate
of output
Quantity of
Output
The Long-Run Aggregate Supply
Curve
In the long-run, an economy’s production
of goods and services depends on its
supplies of labor, capital, and natural
resources and on the available technology
used to turn these factors of production into
goods and services.
The price level does not affect these
variables in the long run.