week 2

Short-Run Aggregate Supply (SRAS) and Long-Run Aggregate Supply (LRAS)

  • Objectives of SRAS:

    • Define "short run" and "sticky input prices".

    • Explain SRAS in relation to input prices and the AD-AS model.

    • Discuss the relationship between price level, aggregate output, inflation, and unemployment.

  • Factors of Production: Include land, labor, and capital. Input costs are the prices paid for these inputs, often fixed through contracts (e.g., labor contracts, leases).

  • Sticky Input Prices: Input prices that do not respond quickly to changes in the price level due to contracts or agreements. The short run is defined by the time it takes for these prices to adjust.

  • SRAS Curve:

    • Upward-sloping because of sticky wages; as prices rise, firms' profitability increases, leading to higher output.

    • A movement along the SRAS curve reflects changes in quantity supplied based on price changes.

  • Trade-offs:

    • In the short run, firms face a trade-off between inflation and unemployment (higher output can lead to higher inflation and lower unemployment).

  • Shift Factors of SRAS:

    • Increase SRAS: Reductions in input costs, increases in productivity, favorable government policies.

    • Decrease SRAS: Increases in input costs, natural disasters, unfavorable government policies.

Long-Run Aggregate Supply (LRAS)

  • LRAS Characteristics: Represents full employment output; vertical line in the AD-AS model unaffected by price level changes.

    • Illustrates the maximum sustainable production capacity of an economy.

  • Long Run vs. Short Run:

    • Long run allows all input prices to adjust; no trade-off between inflation and unemployment.

    • Output is constant at full employment regardless of price level.

  • Determinants of LRAS:

    • Includes technological advancements, increases in resources, improvements in labor skills, and favorable policy changes.

  • Production Possibilities Curve (PPC): Represents potential output levels; shifts in LRAS parallel shifts in the PPC due to increases in production capacity.

    • Points on the PPC indicate full employment; LRAS corresponds to maximum potential output without cyclical unemployment.

Summary Highlights

  • SRAS is subject to price level changes and can exhibit upward slopes due to sticky wages.

  • LRAS is a vertical curve indicating sustainable output at full employment, unaffected by price level fluctuations.