Unit 3 Aggregate Supply

Aggregate Supply.

The LRAS marks the level of full employment in the economy. (Analogous to PPC)

Because input prices are completely flexible in the long run changes in price level do not change firms real profit and therefore do not change firms level of output. This means the LRAS is at the economy's level of full employment. 

LRAS GRAPH

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

 

SRAS GPAPH

An increase in SRAS is seem as a shift to the right. SRAS →
A decrease in SRAS is seem as a shift to the left. SRAS ←

 

The key to understanding shifts in SRAS is per unit cost of production.
Per unit production cost equals total input cost.

Determinants of SRAS
- input prices
- productivity
- legal institutional environment

Input prices.
-Domestic resource prices
   ■wages
   ■cost of capital
   ■raw materials
-foreign resource prices
   ■strong $ equals lower foreign resource prices
   ■weak $ higher foreign resource prices
-market power
   ■monopolies and cartels that control resources control the price of those resources
-increasing in resource prices
-decrease in resource prices

Productivity
 

Equation is total output over total inputs

More productivity is lower unit production cost

Lower productivity is higher unit production cost

Legal institutional environment.
-taxes and subsidies
   ■taces on business increase per unit production cost
   ■subsidies to business reduce per unit production cost
-Government regulation
   ■government regulation creates a cost of compliance SRAS ←
   ■deregulation reduces compliance cost. SRAS →