Unit 3 Notes - Aggregate Supply

· What is 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

-       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

-       The level of Real GDP supplied is directly related to the price level

·      The Long-Run Aggregate Supply or LRAS marks the level of full employment in the economy (analogous to PPC)

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

·      Changes in SRAS

1.     An increase in SRAS is seen as a shift to the right

2.     A decrease in SRAS is seen as a shift to the left

3.     The key to understanding shifts in SRAS is per unit cost of production

·      Per-Unit production cost Formula= total input cost/total output cost

·      Determinants of SRAS

1.     Input Prices (Resource Prices)

2.     Productivity

3.     Legal – Institutional Environment

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

-       Monopolies and cartels that control resources control the price of those resources

·      Increases in Resource Prices = SRAS shift to the left

·      Decreases in Resource Prices = SRAS shift to the right

2.     Productivity

·      Productivity = total output/total input

·      More productivity = lower unit production cost = SRAS shift to the right

·      Lower Productivity = higher unit production cost = SRAS shift to the left

3.     Legal – Institutional Environment

·      Taxes and Subsidies

-       Taxes ($ to government) on business increase per unit production cost = SRAS shifts to the left

-       Subsidies ($ from government) to business reduce per unit production cost = SRAS shifts to the right

·      Government Regulation

-       Government regulation creates a cost of compliance = SRAS shifts to the left

-       Deregulation reduces compliance cost = SRAS shifts to the right