Macroeconomic Models II Aggregate Supply and the Short-run Aggregate Supply (SRAS) Curve How can we combine our understanding of AD with AS to determine Macroeconomic Equilibrium? Is there more than one way to view the AS curve? What impact would that make on public policy?

IB Syllabus: Aggregate Supply What is Aggregate Supply (AS)?  Describe the term aggregate supply  Explain, using a diagram, why the short-run aggregate supply curve (SRAS curve) is upward sloping  Explain, using a diagram, how the AS curve in the short run (SRAS) can shift due to factors including changes in resource prices, changes in business taxes and subsidies and supply shocks Alternate Views of AS  Explain, using a diagram, that the monetarist/new classical model of the long- run aggregate supply curve (LRAS) is vertical at the level of potential output (full employment output) because aggregate supply in the long run is independent of the price level  Explain, using a diagram, that the Keynesian model of the aggregate supply curve has three sections because of “wage/price” downward inflexibility and different levels of spare capacity in the economy Shifts in the AS curve  Explain, using the two models above, how factors leading to changes in the quantity and/or quality of factors of production (including improvements in efficiency, new technology, reductions in unemployment, and institutional changes) can shift the aggregate supply curve over the long term

Aggregate Supply Aggregate Supply: The total quantity of all final goods and services that are expected to be produced in an economy at different price levels, ceteris paribus Short-run Aggregate Supply Curve: The relationship between the Price Level and the quantity of Real GDP produced by firms when resource prices do not change (more on this in a minute) For AS, the relationship between Price Level and Real GDP is _____________________ Question: Why is it upward sloping?

What’s so Special About Wages? Usually the largest part of a firm’s cost of production Tend to be rigid in the short term Labor contracts/labor pressure Minimum wage legislation Firm desire to avoid negative morale Fairness issues

Aggregate Supply Curves Need to differentiate between the Short Run and the Long Run (different definition than we learned in Theory of the Firm): Short-run Aggregate Supply (SRAS) curve: The relationship between the ___________ and the quantity of ___________ produced by firms when resource prices (particularly wages) do not change. In the short run, wages are ____________ Long-run Aggregate Supply (LRAS) curve: The relationship between the ___________ and the quantity of ___________ produced by firms when wages and other resource prices change to fully reflect any changes in the price level. In the long run, wages change in response to changes in the ______________

A Basic SRAS Curve

Changes in AS – Shifts in the Curve Changes/Shifts ≠ Movements along the AS curve Movements: Caused by changes in the price level Shifts: Outward/rightward when AS increases; inward/leftward when AS decreases

Changes in AS Changes in Wages Changes in non-labor resource prices Changes in business taxes Changes in subsidies offered to businesses Supply shocks