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AP Macroeconomics

AP Macroeconomics. Aggregate Supply. Aggregate Supply. The level of Real GDP (GDP R ) that firms will produce at each Price Level (PL) Shows relationship between total quantity supplied by all firms & the overall PL. Long-Run (vertical line)

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AP Macroeconomics

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  1. AP Macroeconomics Aggregate Supply

  2. Aggregate Supply • The level of Real GDP (GDPR) that firms will produce at each Price Level (PL) • Shows relationship between total quantity supplied by all firms & the overall PL

  3. Long-Run (vertical line) 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 (positive slope) Period of time where input prices are sticky: (nominal wages slow to fall even with high unemployment and slow to rise even when labor shortages) and do not adjust to changes in the price-level In the short-run, the level of Real GDP supplied is directly related (positive slope) to the price level Long-Run v. Short-Run A.S.

  4. 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 (been adjusted to economic circumstances) 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

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

  6. Short-Run Aggregate Supply (SRAS) • Because input prices are sticky in the short-run, the SRAS is upward/positive sloping. This reflects the fact that in the short-run, increases in the price-level increase firm’s profits and create incentives to increase output. As the price-level falls, firm’s profits drop and this creates an incentive to reduce output.

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

  8. Changes in SRAS • An increase in SRAS is seen as a shift to the right. SRAS  • Happens when producers increase the quantity of aggregate output they are willing to supply at any given aggregate price level • A decrease in SRAS is seen as a shift to the left. SRAS  • Happens when producers reduce the quantity of aggregate output they are willing to supply at any given aggregate price level • The key to understanding shifts in SRAS is profit per unit of output. • Profit per unit of output = price per unit of output – production cost per unit of output

  9. Changes in SRAS(Increase) PL SRAS SRAS1 GDPR Ex. Lower production cost due to fall in nominal wages would shift SRAS to right because a producer now earns higher profit per unit of output at any given price of output, thus making the producer want to supply more and make more profit.

  10. Changes in SRAS(Decrease) SRAS1 SRAS PL GDPR Ex. Increase in price of oil, a producer now earns a small profit per unit of output (higher input cost), so the producer reduces the quantity supplied at any given aggregate price level.

  11. Determinants of SRAS(all of the following affect profit per unit of output) • Input Prices/nominal wages • Commodities: standardized input bought and sold in bulk quantities • Ex.) oil – SRAS when oil prices decline, thus reducing production cost, leading to increase in quantity supplied at any given aggregate price level • Productivity • Legal-Institutional Environment

  12. Input Prices/Nominal Wages • Domestic Resource Prices • Nominal Wages (75% of all business costs) – usually fixed/inflexable in short run • Nominal wages rise = SRAS shifts left • Nominal wages fall/decrease = SRAS shifts right • Cost of capital • Raw Materials (commodity prices) • Rise in commodity prices = SRAS shifts left • Fall in commodity prices = SRAS shifts right • 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 

  13. Productivity • Productivity = total output/total inputs • More productivity = lower unit production cost = SRAS  • Lower productivity = higher unit production cost = SRAS 

  14. Legal-Institutional Environment • 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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