Aggregate Supply

Aggregate Supply There are three parts the AS curve. is a schedule, showing the level of real domestic output available at each possible price level. There are three parts the AS curve.  1. Keynesian (Horizontal) Range Here price level remains constant with substantial output variation. The economy is below full employment and will therefore have excess capacity. This means production can be increased without fear of having costs increase.

Aggregate Supply 2. Classical (Vertical) Range The economy is at full employment and any attempt to increase production will increase prices. Real domestic output will be constant. 3. Intermediate (Upsloping) Range Expansion of real output is accompanied by a rising price level.

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

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

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

Determinants of Aggregate 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 prices availability of resources price of imported resources Market power The ability to set a price above the point that would be reached in a competitive environment. (If Oil Cartel increases prices the production costs increase. If unions increase prices the production costs increase.)

Determinants of Aggregate Supply 2) Changes in productivity: (technology) Productivity = real output/input If per unit cost decrease the companies become more productive and therefore will be willing to supply more. A shift in AS to the right. 3) Change in legal-institutional environment Business taxes and subsidies Government Regulation

Short Run Aggregate Supply (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

Equilibrium Equilibrium price level and Equilibrium real domestic output Equilibrium: situation in which there are no forces that will produce change among the variables considered.

Ratchet Effect Causes for the Ratchet Effect: This effect states that prices are "sticky" or inflexible in a downward direction. Therefore, aggregate demand will not move downward very freely Causes for the Ratchet Effect: Wage Contracts - contracts prevent firms from decreasing wages, which are a major cost for a firm Morale and Productivity - employers are not willing to reduce wage rates because doing so reduces worker morale and labor productivity Training Investments - firms put an investment in workers when they train them. If workers leave because of lower wages, firms do not get a return from that investment. Minimum Wage - firms cannot reduce wages below minimum wage Monopoly Power - many firms have sufficient monopoly power to resist price cuts for a time when demand declines

Ratchet Effect

cost-push inflation If you go from AS to AS1 you will get falling employment rates and inflation

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

Long Run Aggregate Supply: Moving Along the LRAS Curve The price level does NOT affect long-run aggregate real production. A higher price level generates the same real production as a lower price level.

Long Run Aggregate Supply: Shifting the LRAS Curve Should any of these determinants change, the long-run aggregate supply curve shifts to a new position The long-run aggregate supply curve can either shift rightward (an increase in aggregate supply) or leftward (a decrease in aggregate supply).