Aggregate Supply Curve

Aggregate Supply Curve

• Shows the quantity of goods and services that firms choose to produce and sell at each price level.
  • Upward sloping in the short run.
  • Vertical in the long run.

Aggregate Supply Curves (Figure 1)

• Vertical axis: Overall level of prices.
• Horizontal axis: Economy’s total output of goods and services.

Long-Run Aggregate Supply Curve

• Why is the long-run aggregate-supply curve vertical?
  • Price level does not affect the long-run determinants of GDP.
  • Example: If prices increase by 10%, workers will demand wage increases, and eventually wages should increase by 10%.
  • Monetary Neutrality

The Long-Run Aggregate-Supply Curve (Figure 2)

• In the long run, the quantity of output supplied depends on the economy’s quantities of labor, capital, and natural resources and on the technology for turning these inputs into output.
• Because the quantity supplied does not depend on the overall price level, the long-run aggregate-supply curve is vertical at the natural rate of output.
  • A change in the price level does not affect the quantity of goods and services supplied in the long run.

Natural Rate of Output

• Production of goods and services that an economy achieves in the long run when unemployment is at its natural rate.

Short-Run Aggregate Supply Curve

• Why is the short-run AS curve upward sloping?
  • Sticky-wage theory
  • Sticky-price theory
  • Misperceptions theory

Sticky-Wage Theory

• Nominal wages are slow to adjust to changing economic conditions.
  • Long-term contracts between workers and firms.
  • Slowly changing social norms.
  • Notions of fairness influence wage setting.
• When prices increase:
  • Firm’s revenue increases.
  • With sticky wages, costs don’t increase.
  • Firms can increase production!

The Short-Run Aggregate-Supply Curve (Figure 3)

• In the short run, a fall in the price level from P1 to P2 reduces the quantity of output supplied from Y1 to Y2.
• Over time, however, wages, prices, and perceptions adjust, so this positive relationship is only temporary.
  • An increase in the price level increases the quantity of goods and services supplied in the short run.

Shifts in Aggregate Supply Curves

• What would cause the aggregate supply curves to shift?
  • Changes in labor (L)
  • Changes in capital (K)
  • Changes in natural resources (NR)
  • Changes in technological knowledge (T)

Changes in Labor (L)

• Quantity of workers.
• Quality / skills of workers.
• If L increases, both LR & SR AS shift to the right.

Changes in Capital (K)

• Physical capital:
  • Buildings
  • Equipment
  • Infrastructure
• If K increases, both LR & SR AS shift to the right.

Changes in Natural Resources (NR)

• Availability of natural resources.
• New discovery of natural resources.
• Weather.
• If NR increases, both LR & SR AS shift to the right.

Changes in Technology (T)

• Ideas & Methods of production.
• Labor and capital improvements.
• If T increases, both LR & SR AS shift to the right.

Increases in the Aggregate Supply Curves (Figure 5)

• Illustrates shifts in LRAS and SRAS to the right.

SRAS Shift Without LRAS Shift

• Can SRAS curve shift without LRAS curve shifting?
  • Yes, but unusual.
  • Need unexpected change in input costs (e.g., nominal wages, oil prices).
  • For example, oil price increases of the 1970s caused SRAS to decrease, while LRAS stayed constant.