Unit Three: Aggregate Supply

Aggregate Supply

Notes from 2/18/16

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

Long Run Aggregate Supply (LRAS)

• Period of time where input prices are completely flexible and adjust to changes in the price level
• Level of real GDP supplied is independent of price level 
• Marks level of full employment in the economy (analogous to PPC)
• Since input prices are completely flexible, changes in price level don't change firm's real profits and therefore don't change firm's level of output.
• Means that LRAS is vertical at economy's level of full employment 

Short Run Aggregate Supply (SRAS)

• Period of time where input prices are sticky (hard to shift) and don't adjust to changes in the price level
• Level of real GDP supplied is directly related to price level
• Key to Understanding SRAS is Per Unit Cost of Production
• Per Unit Cost of Production = Total Input Cost / Total Output

Determinants of SRAS

1. Input Prices

• Domestic Resource Prices
• Wages (75% of all Business Costs)
• Cost of Capital (Money Necessary to Begin Business)
• Raw Materials
• Foreign Resource Prices
• Market Power
• Increase in Resource Prices = Shift ←
• Decrease in Resource Prices = Shift →

2. Productivity = Total Output / Total Input

• More Productivity = Lower Unit Production Cost = Shift →
• Less Productivity = Higher Unit Production Cost = Shift ←

3. Legal Institutional Government 

• Taxes and Subsidies
• Taxes (to government) on businesses increase per unit cost of production = Shift ←
• Subsidies (from government) to businesses to reduce per unit of production=
• Shift →
• Government Regulation
• Creates a cost of compliance = Shift ←
• Deregulation reduces compliance cost = Shift → 

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