Aggregate Aggregate SupplySupply

Aggregate SupplyAggregate Supply • is a schedule, showing the level of real domestic is a schedule, showing the level of real domestic

output available at each possible price level.output available at each possible price level. There are three parts the AS curveThere are three parts the AS curve..   1. 1. Keynesian (Horizontal) RangeKeynesian (Horizontal) Range

• Here price level remains constant with Here price level remains constant with substantial output variation. The economy is substantial output variation. The economy is below full employment and will therefore below full employment and will therefore have excess capacityhave excess capacity. .

This means production can be increased without fear of This means production can be increased without fear of having costs increase. having costs increase.

Aggregate SupplyAggregate Supply 2. Classical (Vertical) Range2. Classical (Vertical) Range

• The economy is at full employment and any attempt The economy is at full employment and any attempt to increase production will increase prices. Real to increase production will increase prices. Real domestic output will be constant.domestic output will be constant.

3. Intermediate (Upsloping) Range3. Intermediate (Upsloping) Range • Expansion of real output is accompanied by a rising Expansion of real output is accompanied by a rising

price level. price level.

In the Keynesian In the Keynesian Range the economy is Range the economy is at less than full at less than full employment. This employment. This means that an means that an increase in AD will not increase in AD will not cause an increase in cause an increase in priced because firms priced because firms just employ those just employ those resources that are resources that are remaining idle. remaining idle. (Workers out of work (Workers out of work will not expect a will not expect a wage increase) wage increase)

In the classical range In the classical range the economy is fully the economy is fully employed. It is on its employed. It is on its production possibility production possibility curve. Any increase in curve. Any increase in AD will cause an AD will cause an increase in price with increase in price with no increase in output. no increase in output.

Intermediate (Up sloping) Range: Intermediate (Up sloping) Range: Expansion of real output is accompanied by Expansion of real output is accompanied by a rising price level a rising price level

Determinants of Determinants of Aggregate SupplyAggregate Supply

• (Notice that an increase in AS (shift right) causes an increase in AS (output) for Classical and intermediate ranges but a decrease in price for the Keynesian range.)

1) Change in input prices1) Change in input prices • availability of resources availability of resources • price of imported resources price of imported resources • Market power Market power

The ability to set a price above the point that The ability to set a price above the point that would be reached in a competitive environment. would be reached in a competitive environment. (If Oil Cartel increases prices the production costs (If Oil Cartel increases prices the production costs increase. If unions increase prices the production increase. If unions increase prices the production costs increase.) costs increase.)

Determinants of Aggregate Determinants of Aggregate SupplySupply 2) Changes in productivity: 2) Changes in productivity:

(technology) (technology) • Productivity = real output/inputProductivity = real output/input

If per unit cost decrease the companies become If per unit cost decrease the companies become more productive and therefore will be willing to more productive and therefore will be willing to supply more. A shift in AS to the right.supply more. A shift in AS to the right.

3) Change in legal-institutional 3) Change in legal-institutional environmentenvironment • Business taxes and subsidies Business taxes and subsidies • Government Regulation Government Regulation

Short Run Aggregate Supply Short Run Aggregate Supply (SRAS)(SRAS)

• Shows the total planned output in the economy when the price can change but the price and productivity of all factor inputs E.g. wage rates and the state of technology are held constant

EquilibriumEquilibrium Equilibrium price Equilibrium price

levellevel and and Equilibrium real Equilibrium real domestic outputdomestic output • Equilibrium:Equilibrium: situation in situation in

which there are no which there are no forces that will produce forces that will produce change among the change among the variables considered.variables considered.

Ratchet EffectRatchet Effect This effect states that prices are "sticky" or This effect states that prices are "sticky" or

inflexible in a downward direction. Therefore, inflexible in a downward direction. Therefore, aggregate demand will not move downward very aggregate demand will not move downward very freelyfreely

Causes for the Ratchet Effect:Causes for the Ratchet Effect:• Wage ContractsWage Contracts - contracts prevent firms from decreasing - contracts prevent firms from decreasing

wages, which are a major cost for a firm wages, which are a major cost for a firm • Morale and ProductivityMorale and Productivity - employers are not willing to reduce - employers are not willing to reduce

wage rates because doing so reduces worker morale and labor wage rates because doing so reduces worker morale and labor productivity productivity

• Training InvestmentsTraining Investments - firms put an investment in workers when - firms put an investment in workers when they train them. If workers leave because of lower wages, firms they train them. If workers leave because of lower wages, firms do not get a return from that investment. do not get a return from that investment.

• Minimum WageMinimum Wage - firms cannot reduce wages below minimum - firms cannot reduce wages below minimum wage wage

• Monopoly PowerMonopoly Power - many firms have sufficient monopoly power - many firms have sufficient monopoly power to resist price cuts for a time when demand declinesto resist price cuts for a time when demand declines

Ratchet EffectRatchet Effect

cost-push inflationcost-push inflation If you go from AS to AS1 you will get falling If you go from AS to AS1 you will get falling

employment rates and inflation employment rates and inflation

Long Run Aggregate Long Run Aggregate SupplySupply::

The LRAS curve also The LRAS curve also assumes that the nation assumes that the nation is using all of the is using all of the productive technologies productive technologies available to it. In this available to it. In this manner it is similar to the manner it is similar to the productive possibilities productive possibilities curve. The LRAS curve curve. The LRAS curve moves outward when moves outward when there is economic there is economic growth, but it is still a growth, but it is still a vertical line vertical line

Long Run Aggregate Long Run Aggregate SupplySupply::

Moving Along the LRAS Curve Moving Along the LRAS Curve • The price level does NOT affect long-run aggregate The price level does NOT affect long-run aggregate

real production. A higher price level generates the real production. A higher price level generates the same real production as a lower price level. same real production as a lower price level.

Long Run Aggregate Long Run Aggregate SupplySupply::

Shifting the LRAS Shifting the LRAS CurveCurve• Should any of these Should any of these

determinants change, determinants change, the long-run aggregate the long-run aggregate supply curve shifts to a supply curve shifts to a new position new position

• The long-run The long-run aggregate supply aggregate supply curve can either shift curve can either shift rightward (an increase rightward (an increase in aggregate supply) in aggregate supply) or leftward (a decrease or leftward (a decrease in aggregate supply).in aggregate supply).