Aggregate Supply

Aggregate supply- the level of real GDP (GDPr) that firms will produce at each price level (Pl)

Long run vs Short run
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 price level
-In 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.
-because input prices are completely flexible in the long run, changes in price- level don not change firms' real profits and therefore do not change firms level of output. This means LRAS is vertical at the economy's level of full employment.

Long Run aggregate Supply Graph


Short Run Aggregate supply (SRAS)
-SRAS is upward sloping

Changes in SRAS
-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

formula: per unit production cost = total input cost/ total output

Determinants of SRAS
(all of the following affect unit production cost)
-Input prices
-productivity
-Legal- institutional enviroment

Breakdown...

Input prices
-Domestic resource prices
  -wages (75% of business costs)
  -cost of capital
  -raw materials

- foreign resource prices
  -strong $=lower foreign resource prices
  -Weak $= higher foreign resource prices

-Market Power
  -monopolies and cartels that control resources control the price of these resources.

-Increase in resource prices= SRAS<--
-Decrease in resource prices= SRAS-->

Productivity
-productivity= total output/total input
-more productivity=lower unit production cost=SRAS-->
lower productivity= higher unit production cost=SRAS<--

Legal Institutional enviroment
-Taxes and subsidies
  taxes($ to government) on business increase per unit production cost= SRAS<--
-Government Regulation
  -Government regulation creates a cost of compliance SRAS<--
  Deregulation reduces compliance costs SRAS-->