Short-Run Aggregate Supply (SRAS) Video explanation in 2 minutes or - - PowerPoint PPT Presentation

Short-Run Aggregate Supply (SRAS)

Video explanation in 2 minutes or 12 minutes AND

Long-Run Aggregate Supply (LRAS)

Video explanation in in 3 minutes or 4 minutes

What is Aggregate Supply?

Aggregate Supply is the amount of goods and services (real GDP) that firms will produce in an economy at different price

• levels. The supply for everything by all

firms. Aggregate Supply differentiates between short run and long-run and has TWO DIFFERENT CURVES. Short-Run Aggregate Supply (SRAS)

• Wages and resource prices are

“sticky” and WILL NOT change as price levels change immediately. Long-Run Aggregate Supply (LRAS)

• Wages and resource prices are

“flexible” and WILL change as price levels change eventually.

Shifts in Aggregate Supply

Price Level

Real domestic output (GDPR)

AS An increase or decrease in national production can shift the curve right or left AS1 AS2

Shifters of Short Run Aggregate Supply

• 1. Change in Resource Prices

Prices of Domestic and Imported Resources (Increase in price of American Wheat) (Increase in price of Canadian lumber) (Decrease in price of Chinese steel) Supply Shocks (aka an unexpected change in supply) (Could be a Negative or Positive Supply shock) Inflationary Expectations (If people expect higher prices in the future)

If consumers and producers expect higher prices in the future, workers will demand higher wages and costs will increase.

Shifters of Short Run Aggregate Supply

• 2. Change in Actions (not just spending

more or less) of the Government

Ex: Taxes on Producers (Corporate taxes) Ex: Subsidies for Domestic Producers (Government Payments) Ex: Government Regulations (Government Rules on Businesses)

• 3. Change in Productivity

Technology (New Inventions)

WHY?

WHY?

The Difference Between Short-Run & Long-Run Aggregate Supply

In the short run…

• Wages and resource

prices are sticky and WILL NOT change when price level changes immidiately. In the long run…

• Wages and resource

prices are flexible and WILL change when price level changes eventually.

Simplified Example

If a firm currently makes 100 units that are sold for $1 each, the

• nly cost is $80 of labor. How much is profit?

Profit = $100 - $80 = $20

What happens to profit in the short-run if prices double?

• Now 100 units sell for $2, Total Revenue=$200.
• Profit = $200 - $80 = $120

Firms have an incentive to make more immediately.

What happens in the long-run?

• Workers will eventually demand higher wages to match higher

price levels. So labor costs will eventually double to $160

• Profit = $200 - $160 = $40
• Real Profit is unchanged in the long run

Firms have NO incentive to produce more in the long run since REAL profit is the same.

Long- Run Aggregate Supply (LRAS)

Price level

GDPR

In long run, price level increases but GDP doesn’t. LRAS

QY Full-Employment (Maximum sustainable capacity)

We assume that in the long-run the economy will be producing at full employment.

Shifts in LRAS

Price Level

Real domestic output (GDPR)

LRAS Only a permanent change (not a price change) in the production possibilities of the economy can shift LRAS LRAS1 LRAS2

Shifts in LRAS

Only a permanent change in the production possibilities

• f the economy can shift LRAS

The shifters of the LRAS are the same the shifters of the PPC

Change in resource quantity or quality

OR

Change in technology

GDPR

QY

LRAS

Price Level

Capital Goods Consumer Goods

LRAS1

QY1

The shifters of the LRAS are the same the shifters of the PPC

• 1. Change in resource quantity or quality
• 2. Change in technology

WHY?

A recessionary gap occurs when AD is less than LRAS casing real GDP to fall. An inflationary gap occurs when AD greater than LRAS causing price levels to rise.

Both these gaps will eventually “self correct” in the long run as AD shifts and equilibrium is reestablished, but governments

• ften get involved sooner to attempt and “smooth out” the business cycle with FISCAL POLICY…next slideshow.