Aggregate Supply

Aggregate Supply 

• The level of Real GDP (GDPR) that firms will produce at each Price Level (PL)

Long - Run:

• Period of time where input prices are completely flexible and adjust to changes in the price-level
• In the long run, the level of Real-GDP supplied is independent of the price-level

Short Run:

• Period of time where input prices are sticky and do not adjust to changes in the price-level
• In the short-run, the level of Real GDP supplied is directly related to the price level

Long - Run Aggregate Supply (LRAS)

• The Long - Run Aggregate Supply or (LRAS) marks the level of full employment in the economy (analogous to PPC)

Short - Run Aggregate Supply (SRAS/AS)

• Because input prices are sticky in the short-run, the SRAS is upward sloping

Changes in SRAS

• Increase, Shift to the Right
• Decrease, Shift to the Left
• The key to understanding shift in SRAS is per unit cost of production 

Per-Unit Production Cost = Total input cost / Total Output 

Determinants of SRAS (all of the following affect unit production costs)

1. Input Prices
• Domestic Resources Prices
• Foreign Resource Prices
• Market Power
2. Productivity 
• Productivity = (Total Output / Total Inputs)
3. Legal-Institutional Environment 
• Taxes and Subsidies 
• Government Regulation 

Aggregate Demand

• AD is the demand by consumers, businesses, government, and foreign countries
• Formula: AD = C + I + G + Xn
• Consumption (C)
• Changes in price level cause a move along the curve not a shift of the curve

Aggregate Demand (AD):

• Shows the amount of Real GDP that the private, public and foreign sector collectively desire to purchase at each possible price level
• The relationship between the price level and the level of Real GDP is inverse

Why is AD downward sloping?

1. Wealth Effect:
• Higher prices reduce purchasing power of $
• This decreases the quantity of expenditures 
• Lower price levels increase purchasing power and increase expenditures 
• Example:
• If the balance in your bank was $50,000, but inflation erodes your purchasing power, you will likely reduced your spending
• Price level goes up, GDP demanded goes down
2. Interest-Rate Effect:
• As price level increases, lenders need to charge higher interest rates to get a REAL return on their loans
• Higher interest rates discourage consumer spending and business investment
• Example: Increases in prices leads to an increase in the interest rate from 5% to 25%. You are less likely to take out loans to improve your business.
• Price level goes up, GDP demanded goes down (and vice versa)
3. Foreign Trade Effect:
• When U.S price level rises, foreign buyers purchases fewer U.S. goods and Americans buy more foreign goods
• Exports fall and imports rise causing real GDP demanded to fall. (Xn Decreases)
• Example: If prices triple in the US, Canada will no longer buy US goods causing quantity demanded of US products to fall

Why does AD Shift?

1. Change in Consumer Spending:
• Consumer Wealth 
• More Wealth = More Spending ( AD shifts à )
• Less Wealth = Less Spending ( AD shifts ß )
• Example: ( Boom in the stock market )
• Consumer Expectations
• Positive Expectations = more spending ( AD shifts à )
• Negative Expectations = less spending ( AD shifts ß )
• Example: ( People fear a recession )
• Household Indebtedness
• Less debt = more spending ( AD shifts à )
• More debt = less spending ( AD shifts ß )
• Example: ( More consumer debt )
• Taxes
• Less taxes = more spending ( AD shifts à )
•  More taxes = less spending ( AD shifts ß )
2. Change in Investment Spending:
• Real Interest Rates 
• Future Business Expectations 
• Productivity and Technology 
• Business Taxes 
3. Change in Government Spending
• More Government Spending ( AD shifts à )
• Less Government Spending ( AD shifts ß )
4. Change in Net Exports 
• Exchange Rates (International value of $)
• Strong $ = More Imports and Fewer Exports = ( AD shifts ß )
• Weak $ = Fewer Imports and More Exports = ( AD shifts à )
• National Income Compared to Abroad
• Strong Foreign Economies = More Exports = ( AD shifts à )
• Weak Foreign Economies = Less Exports = ( AD shifts ß )