Aggregate Supply Curve (1.8.26. lecture)

Business Cycles

  • Overview of Business Cycles

    • Business cycles are the fluctuations in economic activity characterized by periods of expansion and recession.

    • Definition of Short Run: The short run is a period during which prices are not fully flexible.

    • Learning Structure: Initial concepts may seem vague but will be clarified with more details in subsequent classes.

  • Key Terminology

    • Recession: A period of economic decline marked by falling GDP, rising unemployment, and decreasing price levels.

    • Expansion: A period of economic growth where GDP rises, unemployment decreases, and price levels increase.

    • Primary Indicators: The three primary indicators used to assess shifts in recessions and expansions:

    1. Aggregate Output: Measured by Real GDP.

    2. Employment of Resources: Measured by unemployment rates.

    3. Price Level Stability: Measured by aggregate price levels and inflation rates.

Economic Indicators and Business Cycles

  • Indicators during Recession and Expansion

    • In Recession:

    • Aggregate Output (Real GDP): Decreases

    • Employment of Resources (Unemployment Rate): Increases

    • Price Level Stability: Typically decreases due to reduced production and consumer spending.

    • In Expansion:

    • Aggregate Output (Real GDP): Increases

    • Employment of Resources (Unemployment Rate): Decreases

    • Price Level Stability: Generally increases due to rising demand and increased consumer spending.

  • Special Case: Stagflation

    • Definition: A situation where GDP decreases while inflation increases.

    • Notable Characteristics: Stagflation presents economic challenges as it combines stagnant economic growth with inflation.

Aggregate Supply Concepts

  • Aggregate Supply Curve (AS)

    • The AS curve represents the total supply of goods and services in the economy and is differentiated into short-run aggregate supply (SRAS) and long-run aggregate supply (LRAS).

    • SRAS typically has a positive slope due to sticky prices and input prices, which do not adjust immediately to changes in demand or economic conditions.

  • Short Run Aggregate Supply (SRAS)

    • Characteristics:

    • Positive slope indicates that as price levels increase, the quantity supplied also increases.

    • Reasons for the slope:

      • Sticky Input Prices: Input prices, like wages, do not adjust quickly to changes, leading to increased production costs that lag behind price movements.

      • Nominal Wages: Defined as the wage rate unadjusted for inflation; important as it remains constant despite changing economic conditions.

  • Producer vs. Employee Perspective in Business Cycles

    • In a recession:

    • Producers: Seek to cut production costs (including wages) to maintain profits.

    • Employees/Workers: May accept lower nominal wages to retain jobs amidst higher unemployment.

    • In an expansion:

    • Producers: Experience greater profits, which may lead to higher wages to attract and retain employees.

    • Employees/Workers: Are less afraid of unemployment and may demand higher wages as economic conditions improve.

Input Prices and Their Sticky Nature

  • Explanation of Sticky Input Prices

    • Sticky prices refer to the tendency of input prices (e.g., wages) to adjust slowly in response to changes in supply and demand conditions due to contracts.

    • For example, a business may not adjust wages until the next contract negotiation, resulting in a lag in price adjustments.

  • Influence of Input Prices on SRAS

    • If input prices rise, producers may not be able to increase supply, leading to a downward shift of the SRAS curve.

    • Conversely, if input prices fall, SRAS can shift upward, indicating increased supply.

Long Run Aggregate Supply (LRAS)

  • Definition and Characteristics

    • LRAS represents the total output of an economy when prices are fully flexible, and all resources are utilized efficiently.

    • Potential Output: The level of GDP the economy would produce if all prices were flexible, associated with full employment and no cyclical unemployment.

    • Graphical Representation: LRAS is depicted as a vertical line (denotes potential output).

    • At potential output, only structural and frictional unemployment exists (not cyclical).

  • Movement of LRAS

    • LRAS can shift based on changes in:

    • Productivity: Increases in human and physical capital or advances in technology shift LRAS to the right.

    • Resources: Increases in available resources can also push LRAS outward.

    • Economic Growth: When LRAS shifts to the right, it reflects economic growth and improved productivity across the economy.

Shifters of Aggregate Supply

  • Factors that lead to shifts in the SRAS curve:

    1. Input prices: Changes in wage levels or commodity prices can shift SRAS.

    2. Expectations of inflation: If producers expect inflation to rise, SRAS may shift left.

    3. Productivity: Changes in productivity levels can lead to SRAS shifts.

    4. Taxes and Regulation: Reductions in business taxes or regulations can shift SRAS to the right, while increases may shift it left.

    5. Government Subsidies: Increased subsidies to businesses tend to enhance production capabilities, shifting SRAS upward.

Summary and Conclusion

  • Reiterating the importance of understanding how business cycles affect economic performance, emphasizing the relationships between employment, output, price stability, and the behavior of producers and consumers in various economic conditions.

  • Understanding both short run and long run aggregate supply is essential to grasp how different economic factors interact and influence overall economic performance.