18 Febraury 2016 [Aggregate Supply (Unit 3)]

Aggregate Supply

Aggregate supply: The level of Real GDP (GDPR) that firms will produce at each price level (PL).

• Long-run: Period of time where input prices are completely flexible and 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 and do not adjust to changes in the price level.
  
  • In the short-run, the level of Real GDP 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 PPC)
• Because input price are completely flexible in the long-run, change in price level do not change firms real profit and therefore do not change firms level of output. This means that the LRSA is vertical at economy level of full employment.

• Short-run Aggregate Supply (SRAS)
• An increase in SRAS is seen as a shift to the right SRAS
• A decrease in SRAS is seen as a shift to the right
• The key to understanding shift in SRAS is per unit cost of production.

Determinate of SRAS

•  Input prices
• Productivity 
• Legal-Institutional Environment

1. Input prices: Wages (75% of all business cost) 
1. Cost of capital
2. Raw material (commodity price)
3. Foreign resource price
• Strong $ = lower foreign 
• Weak $ = strong foreign 
• Increase in resource price = Less SRAS 
2. Productivity 
1. Productivity = Total output / Total input
2. More productivity = lower unit production cost = SRAS -->
3. Lower productivity = higher unit productivity cost = SRAS <-- 
3. Legal - Institute environment 
1. Taxes and Subsides
• Taxes on business increase per unit production cost = SRAS <--
• Subsides to business reduce per unit production cost = SRAS -->
2. Government Regulation
• Government regulation creates a cost of compliance = SRAS <--
• Deregulation reduces compliance cost = SRAS -->