UNIT 3: Aggregate Supply

(2/19/16 - 2/22/16)
                                   

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

                  Long-Run                                          v.                                      Short Run                  
- period of time where input prices are                         - period of time where input prices
completely flexible & adjust to changes                      are sticky and do not adjust to changes
in the price level.                                                          in the price level.

- in the long-run, the level of Real GDP                       - in the short-run, the level of Real GDP
supplied is independent of the price level.                   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 the PPC)
- Because input prices are completely flexible in the long-run, changes in price-level do not change
firms real profits & therefore, do not change firms level of output.
- Means LRAS is vertical at the economy's level of full employment.
Changes in SRAS (Short-Run):
- An increase in SRAS in seen as a shift to the right. (SRAS --->)
- A 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 cost / total output
Determinants of SRAS (all of the following affect unit production cost):
1.) Input Prices
2.) Productivity
3.) Legal-Institution Enviroment

1.) 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
- Increase in Resource Prices = SRAS <---
- Decrease in Resource Prices = SRAS --->

2.) Productivity = total output / total inputs
- More productivity = lower unit production cost = SRAS --->
- Lower productivity = higher unit production cost = SRAS <---

3.) Legal-Institutional Environment:
Taxes & Subsidies...
- taxes ($ to government) on business increase per unit production cost = SRAS <---
- subsidies ($ from government) to business reduce per unit production cost = SRAS --->
Government Regulation...
- Gov regulation creates a cost of compliance = SRAS <---
- Deregulation reduces compliance costs = SRAS --->

                                   

Full Employment:

-Full employment equilibrium exists where AD intersects SRAS & LRAS at the same point.

Recessionary Gap:
- Recessionary gap exists when equilibrium occurs below full employment output.



Inflationary Gap:
- Inflationary gap exists when equilibrium occurs beyond full employment output.