Unit 3: Aggregate Supply

Definition: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
• Short Run: Period of time where input prices are sticky and don't adjust to change in the price level
• Long run Aggregate Supply (LRAS):
•  The LRAS marks level of fall employment in  the economy (analogous to PPC)
• Because input prices are completely flexible in the long-run, change in price-level don't change firm's real profits and thus do not change firms level of output
• Means LRAS is vertical vertical at economies level of full employment 

• Change in SRAS:
• An increase in SRAS it will shift right
• An decrease in SRAS it will shift left
• Key to understanding shifts in SRAS is per unit cost of production
• Per unit production cost = total input cost/ total output

• Determinants of SRAS: ( all of the following affect unit production) 

1. Input prices
2. Productivity 
3. Legal-institutional environment  

Input prices :

• Domestic resource prices

-wages ( 75% of all business costs)

-cost of capital

-raw materials (Commodity Prices)

• Foreign Resource Prices
• Market Power
• Increase in resource prices = SRAS shift left
• Decreases in resources prices = SRAS shift right  

Productivity:

• Total output / Total input 
• More productivity = lower unit production cost = SRAS shift right  
• Lower productivity = higher unit production cost = SRAS shift left

Legal- Institutional Environment:

• Taxes and subsidies:
• Taxes ($ to gov) on business increases per unit production cost = SRAS shifts right
• Subsidies ($ from gov) to business reduce per unit production cost = SRAS shifts right 

• Government regulation: 
• Government regulates creates a cost of compliance = SRAS shifts left
• Regulation reduces compliance costs = SRAS right 

 Full Employment

• Equilibrium exists where AD intersects SRAS & LRAS at the same point .

Recessionary Gap 

• A recessionary gap exists when equilibrium occurs below full employment output.

Inflationary Gap

• An inflationary gap exists when equilibrium occurs beyond full employment output