Aggregate Supply Krugman Section 4 Module 18

Definition  AS is a schedule showing level of real domestic output available at each possible price level.

Short Run Aggregate Supply  Capital & level of technology are fixed  Only quantity of labor changes  SRAS assumes the money wage, resource prices and GDP are constant With these things constant, as the overall price level rises, firms will produce more output With these things constant, as the overall price level rises, firms will produce more output

Possible Shapes of Aggregate Short Run Supply Curve  Horizontal SRAS Curve PL SRAS GDPr

Horizontal  Conditions:  Substantial unemployment and excess capacity  Might be in a recession or depression

Upward sloping or Intermediate Range SRAS Curve PL SRAS GDPr

Upward sloping or Intermediate Range  Conditions:  Closer to full-employment levels  Upward pressure on prices is caused by rising costs of doing business

Vertical Range SRAS Curve PL SRAS GDPr

Vertical Range SRAS Curve  Conditions:  Absolute capacity is assumed—the economy is unable to produce any more G & S for a long period of time  Any attempt to increase output will bid up resource and product prices  Full employment is assumed

Aggregate Range PL GDPr SRAS A B C A = horizontal B = upward sloping C = vertical

Determinants of AS  1. Change in input prices: Availability of resources (4 factors) Availability of resources (4 factors) Prices of imported resources Prices of imported resources Market power of certain industries Market power of certain industries This was also in the eeb book This was also in the eeb book This is the most common determinant This is the most common determinant

Determinants of AS cont.  2. Change in productivity can cause changes in per-unit production cost Productivity rises, unit production costs will  Productivity rises, unit production costs will  Shift to the right and lower pricesShift to the right and lower prices Productivity falls, unit production cost will  Productivity falls, unit production cost will  Shift to the left and increase pricesShift to the left and increase prices

Determinants of AS cont.  3. Change in legal-institutional environment: Business taxes and or subsidies Business taxes and or subsidies Cost of gov’t regulation (pollution clean up) Cost of gov’t regulation (pollution clean up)

Determinants of AS cont.  4. Inflationary expectations Workers will ask for higher wages Workers will ask for higher wages Banks will charge higher interest rates Banks will charge higher interest rates

Change in SRAS?   or NC  1. unions grow more aggressive; wage rates increase  2. labor productivity increases dramatically  3. OPEC successfully increases oil prices  4. computer technology brings new efficiency to industry  5. Gov’t spending increases  6. giant natural gas discovery decreases energy prices  7. cuts in tax rates increase incentives to save  8. low birth rate will decrease the labor force in the future.

Change in SRAS?   or NC  1. unions grow more aggressive; wage rates increase  or shift to the left  or shift to the left  2. labor productivity increases dramatically  or shift to the right  or shift to the right  3. OPEC successfully increases oil prices  or shift to the left  or shift to the left Always think of oil as an input. Many things are made with oil—don’t think just gas Always think of oil as an input. Many things are made with oil—don’t think just gas  4. computer technology brings new efficiency to industry  or shift to the right  or shift to the right  5. Gov’t spending increases NC—gov’t spending would shift the AD curve. NC—gov’t spending would shift the AD curve.

 6. giant natural gas discovery decreases energy prices  or shift to the right  or shift to the right  7. cuts in tax rates increase incentives to save NC— would shift the AD curve NC— would shift the AD curve  8. low birth rate will decrease the labor force in the future. NC—will not affect aggregate supply for 16 years or more—we graph for TODAY. NC—will not affect aggregate supply for 16 years or more—we graph for TODAY. Any questions? Any questions?

Long Run Aggregate Supply PL Output or GDPr LRAS

 Represents the Q of g & s a nation can produce over a sustained period of time using its productive resources efficiently  LRAS is at full employment  4 factors of production will shift the LRAS