Aggregate Supply, Unemployment, and Inflation

Aggregate Supply

• describes the total national output—the behavior of the production side of the economy.

•  the total amount of goods and services that all the factories and businesses in a country are willing and able to produce at every possible price level.

  
  

Short Run (SR)

prices and wages are often "inflexible" or sticky—meaning they don't change right away.

Long Run (LR)

This period lasts longer than a decade.

Long Run (LR)

 prices and wages are perfectly flexible—they have time to adjust to any changes in the economy.

1. Potential Output

2. Production (Input Costs)

Two main factors cause the AS curve to shift (move):

Potential Output

•  is the maximum amount of goods and services the economy can sustainably produce without causing inflation to speed up.

• This capacity grows when there are increases in inputs (like more workers or materials) or technological progress (better ways of making things).

• AS increases (shifts outward/right).

• If potential output increases,

Production (Input) Costs:

These are the costs businesses pay to make goods, like wages, the price of imported materials, and oil prices.

AS increases (shifts down/right)

If production costs decrease (for example, if wages or oil prices fall),_____, because businesses can now make the same amount of output for a lower price.

Keynesian School

•  Believed the AS curve was relatively flat or upward sloping, meaning that changes in demand (AD) could have a significant and lasting effect on output and employment in the short run.

Classical School

• Believed the AS curve was relatively steep or vertical, meaning that the economy's powerful forces would keep it near full employment without government interference.

• Keynesian theory works for the Short Run,

• the Classical approach works for the Long Run.

Reconciliation: The sources suggest both views are partly correct:

Unemployment

is a critical issue. When people are out of work, the economy loses out on the goods and services they would have produced, making the "Social pie smaller".

Unemployment, Making the Social Pie Smaller

This is an opportunity cost (the difference between potential GDP and actual GDP).

Okun’s law

is a crucial connection between how much a country produces (output market) and how many jobs there are (labor market).

• Okun's law states that for every 2 percent that the actual national output (GDP) falls below the economy's maximum potential GDP, the unemployment rate rises by about 1 percentage point.

Explain Okun’s law

the actual GDP of the country must grow just as fast as its potential output.

According to Okun’s law, to prevent the unemployment rate from rising, ______

Frictional Unemployment:

• Occurs because people are always moving between jobs, regions, or stages of life.

• This is often considered voluntary unemployment (people are choosing to look for a better job or their first job).

Structural Unemployment:

• Occurs due to a mismatch between the skills workers have and the skills employers demand (e.g., demand for one type of labor rises while demand for another falls, and markets adjust slowly).

Cyclical Unemployment:

•  Exists when the overall demand for labor is low, typically during a downturn in the business cycle (like a recession).

disequilibrium unemployment

Structural and Cyclical unemployment are examples of

equilibrium unemployment.

Frictional unemployment is considered