Aggregate Supply: Introduction and Determinants Module 18 April 2015

Aggregate Supply Curve Aggregate Supply Curve – shows the relationship between the aggregate price level and the quantity of aggregate output supplied in the economy Nominal wages – the dollar amount of the wage paid Sticky wages – are nominal wages that are slow to fall even in the face of high unemployment and slow to rise even in the face of labor shortages

Agg Supply Curve Short-run aggregate supply curve- shows the relationship between the aggregate price level and the quantity of aggregate output supplied that exists in the short run, the time period when many production costs can be taken as fixed.

Shifts Changes in commodity prices – a standardized input bought and sold in bulk quantities (wheat, oil)…an increase in the production costs…shifts aggregate supply curve to the left. Conversely, a reduction in production costs shifts aggregate supply to the right.

Shifts Changes in Nominal Wages – usually wages are fixed because of contracts or agreements. Nominal changes can change once enough time has passed for contracts to be renegotiated COLA – cost of living allowance (teachers haven’t gotten this for 9 years)

Shifts Changes in Productivity – for example, when stores switched to bar code scanners instead of personnel to price, stock, and inventory.

Long-Run Aggregate Supply Curve The Long-Run Aggregate Supply Curve shows the relationship between the aggregate price level and the quantity of aggregate output supplied that would exist if all prices, including nominal wages, were fully flexible. If the prices of ALL inputs were halved, it would have not effect on the economy’s aggregate output…changes in the aggregate price level now have no effect on the quantity of aggregate output supplied.

Long-Run Aggregate Supply Curve

Agg Supply Curve It is vertical because changes in the aggregate price level have no effect on aggregate output in the long run. It’s important to understand not only that the LRAS curve is vertical but also that its position along the horizontal axis marks an important benchmark for output. The LRAS in the figure touches $800 billion, and is the economy’s potential output – the level of real GDP the economy would produce if all prices, including nominal wages, were fully flexible.

Agg Supply Curve

Agg Supply Curve U.S. potential has risen steadily over time – the rightward shifts are related to the following: Increases in the quantity of resources, including land, labor, capital, and entrepreneurship Increases in the quality of resources, as with a better-educated workforce Technological progress

Agg Supply Curve The Short-Run and Long-Run can appear in one of only two states. It can be on both curves simultaneously by being a point where the curves cross Or, it can be on the short-run aggregate supply curve but not the long-run aggregate supply curve (where the potential output does not coincide).

Agg Supply Curve

Check Your Understanding 1. Determine the effect on short-run aggregate supply of each of the following events. Explain whether it represents a movement along the SRAS curve or a shift of the SRAS curve. A. a rise in the consumer price index (CPI) leads producers to increase output B. a fall in the price of oil leads producers to increase output C. a rise in legally mandated retirement benefits paid to workers leads producers to reduce output.

Check Your Understanding 2. Suppose the economy is initially at potential output and the quantity of aggregate output supplied increases. What information would you need to determine whether this was due to a movement along the SRAS curve or a shift of the LRAS curve?

MC ??? 1. Which of the following will shift the short- run aggregate supply curve? A change in A. profit per unit at any given price level B. commodity prices C. nominal wages D. Productivity E. all of the above

MC ?? 2. Because changes in the aggregate price level have no effect on aggregate output in the long run, the long-run aggregate supply curve is A. vertical B. horizontal C. fixed D. negatively sloped E. positively sloped

MC ??? 3. The horizontal intercept of the long-run aggregate supply curve is A. at the origin B. negative C. at potential output D. equal to the vertical intercept E. always the same as the horizontal intercept of the short-term aggregate supply curve.

MC ??? 4. A decrease in which of the following will cause the short-run aggregate supply curve to shift to the left? A. commodity prices B. the cost of health care insurance premiums paid by employees C. nominal wages D. productivity E. the use of cost-of-living allowances in labor contracts

MC ???? 5. That employers are reluctant to decrease nominal wages during economic downturns and raise nominal wages during economic expansions leads nominal wages to be described as A. long-run B. unyielding C. flexible D. real E. sticky

Free-Response 1. a. Draw a correctly labeled graph illustrating a long-run aggregate supply curve B. on your graph from part a, label potential output C. illustrate an increase in long-run aggregate supply D. what could have caused the change you illustrated? List 3 possible causes