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AP Macroeconomics

AP Macroeconomics. Aggregate Supply 10-1-12 It’s October!. Aggregate Supply. The level of Real GDP (GDP R ) that firms will produce at each Price Level (PL). Short-Run Aggregate Supply (SRAS). PL. SRAS. GDP R. Short-Run

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AP Macroeconomics

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  1. AP Macroeconomics Aggregate Supply 10-1-12 It’s October!

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

  3. Short-Run Aggregate Supply (SRAS) PL SRAS GDPR

  4. Short-Run Reminder--Input cost are labor and capital (machinery, raw materials, land etc.) Period of time where input costs are “sticky” and do not adjust to changes in the price-level (LABOR) If prices go up (down), it takes some time for input prices to change to reflect the price increase (decrease) In the short-run, the level of Real GDP supplied is directly related to the price level Characteristics of Short-Run

  5. Short-Run Aggregate Supply (SRAS) • This reflects that in the short-run, increases in the price-level increase firm’s profits and create incentives to increase output. The increase in output is reflected by an increase in GDP. • Because input costs are sticky in the short-run, the SRAS is upward sloping.

  6. Short-Run Aggregate Supply (SRAS) • As the output increases input prices increase (overtime) • Firm’s profits drop and this creates an incentive to reduce output. • At first it’s easy to employ unused capital to increase production. Gets costlier later on.

  7. Changes in SRAS • An increase in SRAS is seen as a shift to the right. SRAS  • A decrease in SRAS is seen as a shift to the left. SRAS 

  8. Changes in SRAS(Increase) PL SRAS SRAS1 GDPR

  9. Changes in SRAS(Decrease) SRAS1 SRAS PL GDPR

  10. Determinants of SRAS(all of the following affect per-unit production cost) • Input Prices • Labor (about 75% of input prices in US) • Capital • Land (Raw Material) • Productivity • Legal-Institutional Environment

  11. Characteristics of Long Run • 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

  12. Long-Run Aggregate Supply (LRAS) • Long run is the time period in which input costs and sales prices are flexible • LRAS curve is vertical at the economy’s full-employment output LRAS represents full employment output. It doesn’t matter where you draw LRAS—it always shows FE.

  13. Long-Run Aggregate Supply (LRAS) PL LRAS Yf GDPR

  14. Long-Run Aggregate Supply (LRAS) • To produce more than full employment output overtime is necessary. • Input prices (labor) will go up • When input prices are free to change, the high demand for them will start to raise input pricesand lead to cost push inflation

  15. Long-Run Aggregate Supply (LRAS) • As input prices increase firms profits will fall until rise in input prices match the change in output prices. • Firm profits return to original levels and firms will be motivated to produce at FE output level

  16. Long-Run Aggregate Supply (LRAS) • The Long-Run Aggregate Supply or LRAS marks the level of full employment in the economy (analogous to PPC) • Because input prices are completely flexible in the long-run, changes in price-level do not change firms’ real profits and therefore do not change firms’ level of output. This means that the LRAS is vertical at the economy’s level of full employment

  17. Input Prices • Domestic Resource Prices • Wages (75% of all business costs) • CETERIS PARIBUS, decrease in wages reduce per-unit production costs. AS moves to the right. • Example: Labor supply increases because of substantial immigration. Wages and per-unit production costs fall and AS shifts to the right. • Increase in wages increases per-unit production costs. AS moves to the left • Example: Labor supply decreases because a rapid increase in pension income causes many older workers to opt for early retirement. Wage rates and per-unit production costs rise and AS shifts to the left • Cost of capital • Raw Materials (commodity prices)

  18. Input Prices • Foreign Resource Prices • Strong $ = lower foreign resource prices • Weak $ = higher foreign resource prices • Market Power • Monopolies and cartels that control resources control the price of those resources • Increases in Resource Prices = SRAS  • Decreases in Resource Prices = SRAS 

  19. Productivity • Productivity = total output/total inputs • Can change when more productive methods are used. • Technology • Business practices (JIT manufacturing) • More productivity = lower unit production cost = SRAS  • Lower productivity = higher unit production cost = SRAS 

  20. Legal-Institutional Environment • Business Taxes and Subsidies • Taxes ($ to gov’t) on business increase per unit production cost = SRAS  • Subsidies ($ from gov’t) to business reduce per unit production cost = SRAS  • Government Regulation • Government regulation creates a cost of compliance = SRAS  • Deregulation reduces compliance costs = SRAS 

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