Module 18- The Short Run Aggregate Supply Curve By J.A.SACCO

Short Run Aggregate Supply The Short Run is the period that begins immediately after an increase in the price level and ends when input prices have increased in the same proportion to the increase in the price level. Input prices are the fees paid to providers of input goods/services Wages to workers (nominal) Rent paid to landowners Interest paid to providers of capital Prices paid to suppliers of intermediate goods

Short Run Aggregate Supply Therefore the SRAS represents the relationship between the price level and the real output of goods/services in the economy without full adjustment and without full information (nominal values not real values). The SRAS will be drawn under the assumption that all determinants of supply other than the price level will be held constant.

The Short-Run Aggregate Supply Curve SRAS The SRAS slopes upward because with fixed costs (nominal) at a higher price level firms make more profits and desire more output. 120 Price Level 100 1 2 3 4 5 6 7 8 9 Real GDP per Year ($ trillions)

PROFIT 1 The Shape of the SRAS Revenue > Input Costs 3 2 Range1 (Flat/Keynesian) – Input prices (wages, factors of production) are constant in nominal terms. These input prices cost less than output of Real GDP. 3 2 1 Revenue > Input Costs PROFIT

2 Profits decreasing! The Shape of the SRAS Range 2 (Intermediate) Some input costs beginning to rise due to scarcity. Input costs catching up to revenue. Beginning to reach maximum output. 3 2 1 Input Costs catching up to Revenue! Profits decreasing!

3 The Shape of the SRAS NO PROFIT!! 2 1 Range 3 (Classical/Vertical) Input costs are now equal to revenue. Input costs are in proportion to the price level. No incentive for producers to supply more. No more profit!! 3 2 1 As you move along the SRAS, the lagtime between input costs and profits becomes shorter and shorter until input costs equals revenue. NO PROFIT!!

Short Run Aggregate Supply Therefore, what is held constant are prices of inputs (nominal) used in the production of all goods and services. If the price of inputs are constant (nominal) And the price level rises Then Firms will expand supply and make a profit Furthermore, in the short run, if the price level rises, output can expand temporarily even beyond (LRAS) the economist’s notion of the normal capacity of a firm and thus the entire economy.

Producing Beyond the Long Run in the Short Run LRAS How can you produce temporarily beyond LRAS?

Why Can Output Be Expanded in the Short Run? Use Labor More Intensively Have workers work harder by increasing the length of the work and the number of days worked Switch workers from uncounted production to counted production that generates output With labor being paid in nominal wages based on yearly contracts, employers are paying less in wages than the increase in the price level. The nominal wage does not keep up to inflation (real wage). A lagtime exists. Use Capital More Intensively Machines can be worked longer, faster, and maintenance delayed to reduce down time.

Why Can Output Be Expanded in the Short Run? Employ More Workers As profits increase, producers hire more workers, unemployment rate falls and people begin to enter the labor force Increased production can not go on forever even if the price level rises which is why the SRAS begins to slope upward When Capacity is Reached Workers become less willing to work longer Machines break down and must be repaired It becomes harder to find workers at the existing (nominal wage) as scarcity sets in. Eventually your input costs rises, because of scarcity, in proportion to the price level. No more profit.

Non-Price Level Determinants of Aggregate Supply Changes That Cause an Increase (Shift) in Aggregate Supply A reduction in input prices/decrease in nominal wage Discoveries of new raw materials Increased competition A reduction in international trade barriers Fewer regulatory impediments to business An increase in labor supplied Increased training and education A decrease in marginal tax rates A temporary change will shift only the SRAS, a permanent change will shift both the SRAS and the LRAS!

Shifts in SRAS Only LRAS1 SRAS1 SRAS2 Price Level 1 2 3 4 5 6 7 8 9 1 2 3 4 5 6 7 8 9 Real GDP per Year ($ trillions)

Non- Price Level Determinants of Aggregate Supply Changes That Cause a Decrease (Shift) in Aggregate Supply An increase in input prices/increase in nominal wage Depletion of raw materials Decreased competition An increase in international trade barriers More regulatory impediments to business An decrease in labor supplied Decreased training and education An increase in marginal tax rates

Shifts in SRAS Only LRAS1 SRAS2 SRAS1 Price Level 1 2 3 4 5 6 7 8 9 1 2 3 4 5 6 7 8 9 Real GDP per Year ($ trillions)

Shifts in Both Short-and Long-Run Aggregate Supply LRAS1 LRAS2 SRAS1 SRAS2 Any permanent change in a factor of production will shift both short- and long-run aggregate supply. Price Level 1 2 3 4 5 6 7 8 9 Real GDP per Year ($ trillions)