Ch. 10- The Short Run Aggregate Supply Curve

1. Ch. 10- The Short Run Aggregate Supply Curve By J.A.SACCO

2. Short Run Aggregate Supply • The Short Run is the period that begins immediately after an increase in the price level and ends when input prices have increased in the same proportion to the increase in the price level. • Once again the key to the upward slope of the SRAS is profit. The direct relationship between price level and output. • Input prices are the fees paid to providers of input goods/services • Wages to workers (some nominal/ ”sticky”wages) • Rent paid to landowners • Interest paid to providers of capital • Prices paid to suppliers of intermediate goods

3. Short Run Aggregate Supply • Therefore the SRAS represents the relationship between the price level and the real output of goods/services in the economy without full adjustment and full information (some nominal values not real values). • The SRAS will be drawn under the assumption that all determinants of supply other than the price level will be held constant.

4. SRAS The SRAS slopes upward because at a higher price level firms make more profits and desire more output. 120 100 The Short-RunAggregate Supply Curve Price Level 0 1 2 3 4 5 6 7 8 9 Real GDP per Year ($ trillions)

5. Two Supply Curves Compared! Is the microeconomic supply curve and the SRAS the same? Different?

6. The Shape of the SRAS • Range1 (Flat/Keynesian) • Many unused resources • Some factors of production, including wages, are constant (nominal/”sticky”) • These input prices cost less than output of Real GDP. • Firms able to expand production to meet demand- huge profit! 3 2 1 Revenue Input Costs >

7. The Shape of the SRAS • Range 2 (Intermediate) Some input costs beginning to rise due to scarcity. • Wage contracts beginning to reflect inflation • Input costs catching up to revenue • Beginning to reach maximum output. 3 2 1 Input Costs catching up to revenue. Profit decreasing!

8. The Shape of the SRAS • Range 3 (Vertical) • Input costs are now equal to revenue. • Factors of production fully utilized • Input costs are in proportion to the price level. Zero profit! • No incentive for producers to supply more. 3 2 1 As you move along the SRAS, the lagtime between input costs and revenue becomes shorter and shorter until input costs equals revenue.

9. Short Run Aggregate Supply Once again, the key is profit! If the price of inputs are constant (nominal) Then Firms will expand supply and make a profit And the price level rises Furthermore, in the short run, if the price level rises, output can expand temporarily even beyond (LRAS) the economist’s notion of the normal capacity of a firm and thus the entire economy.

10. Producing Beyond the Long Run in the Short Run • How can output temporarily go beyond LRAS/natural rate of output?

11. Why Can Output Be Expanded in the Short Run? • Use Labor More Intensively • Have workers work harder by increasing the length of the work and the number of days worked • Switch workers from uncounted production to counted production that generates output • Some labor being paid in nominal wages based on yearly contracts, employers are paying less in wages than the increase in the price level. The nominal wage (“sticky wage”) does not keep up with inflation (real wage). A lagtime exists. • Use Capital More Intensively • Machines can be worked longer, faster, and maintenance delayed to reduce down time.

12. Why Can Output Be Expanded in the Short Run? • Employ More Workers • As profits increase, producers hire more workers, unemployment rate falls and people begin to enter the labor force Increased production can not go on forever even if the price level rises which is why the SRAS begins to slope upward • When Capacity is Reached • Workers become less willing to work longer • Machines break down and must be repaired • It becomes harder to find workers at the existing (nominal wage) as scarcity sets in. • Eventually your input costs rise, because of scarcity, in proportion to the price level. No more profit!

13. Shifting the SRAS • Just like the AD curve, non-price level determinants will shift the SRAS.

14. Determinants ofAggregate Supply Changes That Cause an Increase in Aggregate Supply Discoveries of new raw materials Increased competition A reduction in international trade barriers Fewer regulatory impediments to business An increase in labor supplied Increased training and education A decrease in marginal tax rates A reduction in input prices

15. LRAS1 SRAS2 SRAS1 Shifts in SRAS Only Price Level 0 1 2 3 4 5 6 7 8 9 Real GDP per Year ($ trillions)

16. Determinants ofAggregate Supply Changes That Cause a Decrease in Aggregate Supply Depletion of raw materials Decreased competition An increase in international trade barriers More regulatory impediments to business A decrease in labor supplied Decreased training and education An increase in marginal tax rates An increase in input prices

17. LRAS1 SRAS1 SRAS2 Shifts in SRAS Only Price Level 0 1 2 3 4 5 6 7 8 9 Real GDP per Year ($ trillions)

18. LRAS1 LRAS2 SRAS1 SRAS2 Shifts in Both Short-andLong-Run Aggregate Supply Any permanent change in a factor of production will shift both short- and long-run aggregate supply. Price Level 0 1 2 3 4 5 6 7 8 9 Real GDP per Year ($ trillions)