2. AGGREGATE SUPPLY
• The aggregate supply curve shows
the relationship between the
aggregate price level and the
quantity of aggregate output
supplied in the economy.
• There is a distinction between the
short-run and the long-run aggregate
supply curves.
2
3. THE SHORT-RUN AGGREGATE
SUPPLY CURVE
• There is a positive relationship, in the
short run, between the aggregate
price level and the quantity of
aggregate output supplied.
• Other things equal, a rise in the
aggregate price level is associated
with a rise in the quantity of
aggregate output supplied; a fall in
the aggregate price level is
associated with a fall in the quantity
of aggregate output supplied. 3
4. UPWARD SLOPING SHORT-RUN
AGGREGATE SUPPLY CURVE
• Producers will produce more goods
and services the more profitable it is
for them .
• Profit per unit of output= Price per unit
of output – Production cost per unit of
output
4
5. WHY IS THE SHORT-RUN AGGREGATE
SUPPLY CURVE UPWARD SLOPING?
• Is the price the producer receives for
a unit of output greater or less than
the cost of producing that unit of
output?
• Remember that many of the costs
producers face are fixed per unit of
output and can’t be changed for a
certain period of time.
5
6. “STICKY” WAGES
• Wages are typically an inflexible
production cost because nominal
wages are determined by contracts
that were signed some time ago.
• Companies are also reluctant to
change wages in response to
economic conditions.
6
7. “STICKY” WAGES
• Producers won’t lower wages in times
of an economic downturn (unless it is
particularly long and severe) for fear
of creating worker resentment.
• Producers won’t raise wages during
good economic times (until they are
at risk of losing employees to
competitors) as they won’t want to
encourage them to routinely
demand higher wages.
7
8. “STICKY” WAGES
• Therefore, the economy is
characterized by sticky wages:
nominal wages that are slow to fall
even in the face of high
unemployment and slow to rise even
in the face of labor shortages.
• Sticky wages cannot be sticky
forever, as ultimately, formal
contracts and informal agreements
will be renegotiated to take the
economic circumstances into
account. 8
9. SHORT RUN TO LONG RUN
• How long it takes for nominal wages
to become flexible is the integral
component that differences the short
run from the long run.
9
10. SUPPLY TO AGGREGATE SUPPLY
• Remember from microeconomics
that perfectly competitive firms will
supply more of a good when the
price is higher, increasing the
output, to increase profit.
• Conversely, when the price falls, the
profit falls as well, so perfectly
competitive firms will decrease
output in response to a falling price.
10
11. SUPPLY TO AGGREGATE SUPPLY
• Now imagine an imperfectly
competitive producer that sets its own
price: if there is a rise in demand for his
product, he will be able to sell more at
any given price, so he will probably
choose to increase his prices as well
as his output, to increase profit.
• An industry’s “pricing power” means
that when demand is strong, firms with
pricing power are able to raise prices-
and they do.
11
12. SUPPLY TO AGGREGATE SUPPLY
• Conversely, when there is a fall in
demand, firms will try to limit the fall in
their sales by cutting prices.
• Therefore, the response of firms in
both perfectly competitive industries
and imperfectly competitive
industries lead to an upward-sloping
relationship between aggregate
output and the aggregate price
level.
12
13. SHORT RUN AGGREGATE SUPPLY CURVE
• The short-run aggregate supply curve
shows relationship between the
aggregate price level and the
quantity of aggregate output
supplied that exists during the short
run, which is the time period when
many production costs (particularly
nominal wages), can be taken as
fixed.
13
14. SHORT RUN AGGREGATE SUPPLY CURVE
• The positive relationship between the
aggregate price level and
aggregate output in the short run
gives the short-run aggregate supply
curve its upward slope.
14
16. SHIFTS OF THE SHORT RUN
AGGREGATE SUPPLY CURVE
• Movements along the short-run
aggregate supply curve (SRAS) are
due to changes in the aggregate
price level.
• However, there can also be shifts of
the SRAS curve.
• A decrease in SRSA means a shift
leftward of the curve and an
increase in SRAS means a shift
rightward of the curve.
16
17. SHIFTS OF THE SHORT RUN
AGGREGATE SUPPLY CURVE
• Aggregate supply increases when
producers increase the quantity of
aggregate output they are willing to
supply at any given aggregate price
level.
• Anything that changes the
production costs will change the
amount of profit the producer
earns, and will shift the SRAS curve.
17
18. SHIFTS OF THE SHORT RUN
AGGREGATE SUPPLY CURVE
• There are three important factors
that affect producer’s profit per unit
and shifts in the SRAS curve:
1. Changes in commodity prices
2. Changes in nominal wages
3. Changes in productivity
18
19. CHANGES IN COMMODITY PRICES
• A commodity is a standardized input
bought and sold in bulk quantities.
They are not a final good, so their
prices are not included in the
calculation of the aggregate price
level.
• However, commodities represent a
significant cost of production to
most suppliers, so their prices have
large impacts on production costs.
19
20. CHANGES IN COMMODITY PRICES
• An increase in the price of a
commodity raises production costs
across the economy and reduces
the quantity of aggregate output
supplied at any price level, shifting
the SRAS curve to the left.
• Conversely, a decrease in
commodity prices reduces the
production costs, leading to an
increase in the quantity supplied at
any aggregate price level and a
rightward shift of the SRAS curve. 20
21. CHANGES IN NOMINAL WAGES
• Dollar wages are fixed because they
are set by contracts or informal
agreements made in the past.
• However, once enough time has
passed for the contracts and
agreements to be
renegotiated, these nominal wages
can change.
• This will increase production costs
and shift the SRAS curve to the left.
21
22. CHANGES IN NOMINAL WAGES
• Conversely, when there is a fall in the
nominal wages, this will reduce
production costs and shift the SRAS
curve to the right.
22
23. CHANGES IN NOMINAL WAGES
• An increase in the price of a
commodity will have a “knock on”
effect which magnifies the leftward
shift of the SRAS curve when there
are cost-of-living allowances built
into the wage contracts.
• The increase in commodity prices will
lead to an increase in overall
consumer prices, which then causes
a rise in nominal wages.
23
24. CHANGES IN PRODUCTIVITY
• An increase in productivity means
that a worker can produce more
units of output with the same
quantity of inputs.
• When productivity
increases, producer costs fall and
profits rise.
24
25. CHANGES IN PRODUCTIVITY
• Therefore, a rise in productivity
increases the producer’s profits and
shifts the SRAS curve to the right.
• Conversely, a fall in productivity
reduces the number of units of
output a worker can produce with
the same quantity of inputs. The cost
per unit of output rises, profit
falls, and quantity supplied falls. This
shifts the SRAS curve to the left.
25
26. FACTORS THAT SHIFT THE SHORT-RUN
AGGREGATE SUPPLY CURVE
CHANGES IN If commodity prices fall… SRAS increases
COMMODITY If commodity prices rise… SRAS decreases
PRICES
If nominal wages fall… SRAS increases
CHANGES IN If nominal wages rise… SRAS decreases
NOMINAL WAGES
If workers become more SRAS increases
CHANGES IN
productive…
PRODUCTIVITY
If workers become less SRAS decreases
productive…
26
27. THE LONG-RUN AGGREGATE SUPPLY CURVE
• In the long run, nominal wages are
flexible, not sticky.
• This wage flexibility alters the long-run
relationship between the aggregate
price level and aggregate supply.
• In the long run, the aggregate price
level has no effect on the quantity of
aggregate output supplied.
• Therefore the long run is defined as
the period of time in which all prices
are fully flexible.
27
28. THE LONG-RUN AGGREGATE SUPPLY CURVE
• In the long run, inflation or deflation
has the same effect as changing all
the prices by the same proportion.
• As a result, changes in the aggregate
price level don’t change the quantity
of aggregate output supplied in the
long run.
• Changes in the aggregate price
level, in the long run, will be
accompanied by equal proportional
changes in all input prices, including
nominal wages. 28
29. THE LONG-RUN AGGREGATE SUPPLY CURVE
• The long-run aggregate supply curve
shows the relationship between the
aggregate price level and the
quantity of aggregate output
supplied that would exist if all
prices, including nominal
wages, were fully flexible.
• The LRAS curve is vertical because
changes in the aggregate price level
have no effect on aggregate output
in the long run.
29
30. THE LONG-RUN AGGREGATE SUPPLY CURVE
• The position of the LRAS curve on the
horizontal axis is an important
benchmark for output.
• The LRAS curve is located at the
point of potential output, the level of
real GDP the economy would
produce if all prices, including
nominal wages, were fully flexible.
• This point defines the trend around
which actual output fluctuates from
year to year.
30
32. SHIFTS IN THE LRAS CURVE
• Rightward shifts in the LRAS curve are
related to long-run economic
growth:
1. Increase in the quantity of resources,
including land, labor, capital, and
entrepreneurship
2. Increases in the quality of resources
3. Technological progress
32
33. SHIFTS IN THE LRAS CURVE
• Long-run economic growth is growth
in the economy’s potential output.
• The LRAS curve shifts to the right over
time as economy experiences long-
run growth.
33
34. FROM THE SHORT RUN TO THE LONG RUN
• The economy normally produces
more or less than potential output.
• So the economy is normally on its
SRAS curve but not on its LRAS curve.
34
35. FROM THE SHORT RUN TO THE LONG RUN
• The economy is always in one of two
states with respect to the short-run and
long-run aggregate supply curves:
1. It can be on both curves
simultaneously, by being on the point
where both curves intersect (when
both actual and potential output
coincide)
2. It can be on the SRAS curve but not on
the LRAS curve (when actual
aggregate output and potential
output do not coincide).
35
37. FROM THE SHORT RUN TO THE LONG RUN
• If the economy is on the short-run but
not the long-run aggregate supply
curve, the SRAS curve will shift over
time until the economy is at a point
where both curves cross-a point
where actual aggregate output is
equal to potential output.
37
39. EQUILIBRIUM IN THE LONG RUN
Read through the Figure 18.5 on
page 187 to see how the process
of adjusting from a point higher
than or lower than actual output
will tend to shift the SRAS curve
back to intersect with the LRAS
curve at potential output.
39
