Unit 3: Aggregate Supply 2/21/17

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

Long Run: 
- Input prices are completely flexible & 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 & do not adjust to changes in the price level.
- The level of GDP supplied is directly related to the price level.

Long-Run Aggregate Supply (LRAS)
- The LRAS marks the levels of full employment

Short-Run Aggregate Supply (SRAS)

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

Changes in SRAS:

• An increase in SRAS is seen as a shift to the right. SRAS ->
• Decrease in SRAS is seen as a shift to the left. SRAS <-
• The key to understanding shifts in SRAS is per unit cost of production.

Per unit production cost = Total Input 

                                          Total output

Increase:


  Decrease:

Determinants of SRAS

1. Input Prices:

Domestic Resource Prices

- Wages (75% of all business costs)

- Cost of capital

- Raw materials

Foreign Resource Prices

- Strong $ = lower foreign resource prices

- Weak $ = higher foreign resource prices

Market Power

- Monopolies & cartels 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 govt) on business increase per unit
   Production cost = SRAS <--
- Subsidies ($ from govt) to business reduce per unit
  Production cost = SRAS -->
Government Regulation
- Govt regulation creates a cost of compliance = SRAS <--
- Deregulation reduces compliance costs = SRAS -->