Aggregate SupplyAggregate Supply

Krugman Section 4 Module 18Krugman Section 4 Module 18

DefinitionDefinition

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

Possible Shapes of Aggregate Possible Shapes of Aggregate Short Run Supply CurveShort Run Supply Curve

Horizontal SRAS CurveHorizontal SRAS Curve

PL

SRAS

GDPr

HorizontalHorizontal

Conditions:Conditions: Substantial unemployment and excess Substantial unemployment and excess

capacity capacity Might be in a recession or depressionMight be in a recession or depression

Upward sloping or Intermediate Upward sloping or Intermediate Range SRAS CurveRange SRAS Curve

PLSRAS

GDPr

Upward sloping or Intermediate Upward sloping or Intermediate RangeRange

Conditions:Conditions: Closer to full-employment levelsCloser to full-employment levels Upward pressure on prices is caused by Upward pressure on prices is caused by

rising costs of doing businessrising costs of doing business

Vertical Range SRAS CurveVertical Range SRAS Curve

PL

SRAS

GDPr

Vertical Range SRAS CurveVertical Range SRAS Curve

Conditions:Conditions: Absolute capacity is assumed—the Absolute capacity is assumed—the

economy is unable to produce any more G economy is unable to produce any more G & S for a long period of time& S for a long period of time

Any attempt to increase output will bid up Any attempt to increase output will bid up resource and product pricesresource and product prices

Full employment is assumedFull employment is assumed

Aggregate RangeAggregate Range

PL

GDPr

SRAS

AB

C

A = horizontalB = upward slopingC = vertical

Determinants of ASDeterminants of AS

1. Change in input prices:1. Change in input prices: Availability of resources (4 factors)Availability of resources (4 factors) Prices of imported resourcesPrices of imported resources Market power of certain industriesMarket power of certain industries

This was also in the eeb bookThis was also in the eeb book This is the most common determinantThis is the most common determinant

Determinants of AS cont.Determinants of AS cont.

2. Change in 2. Change in productivityproductivity can cause can cause changes in per-unit production costchanges 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.Determinants of AS cont.

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

Determinants of AS cont.Determinants of AS cont.

4. Inflationary expectations4. Inflationary expectations Workers will ask for higher wagesWorkers will ask for higher wages Banks will charge higher interest ratesBanks will charge higher interest rates

Change in SRAS? Change in SRAS? or NC or NC 1. unions grow more aggressive; wage rates 1. unions grow more aggressive; wage rates

increaseincrease 2. labor productivity increases dramatically2. labor productivity increases dramatically 3. OPEC successfully increases oil prices3. OPEC successfully increases oil prices 4. computer technology brings new efficiency to 4. computer technology brings new efficiency to

industryindustry 5. Gov’t spending increases5. Gov’t spending increases 6. giant natural gas discovery decreases energy 6. giant natural gas discovery decreases energy

pricesprices 7. cuts in tax rates increase incentives to save7. cuts in tax rates increase incentives to save 8. low birth rate will decrease the labor force in 8. low birth rate will decrease the labor force in

the future.the future.

Change in SRAS? Change in SRAS? or NC or NC

1. unions grow more aggressive; wage rates increase 1. unions grow more aggressive; wage rates increase or shift to the leftor shift to the left

2. labor productivity increases dramatically2. labor productivity increases dramatically or shift to the rightor shift to the right

3. OPEC successfully increases oil prices3. OPEC successfully increases oil prices or shift to the leftor shift to the left Always think of oil as an input. Many things are made with Always think of oil as an input. Many things are made with

oil—don’t think just gasoil—don’t think just gas 4. computer technology brings new efficiency to industry4. computer technology brings new efficiency to industry

or shift to the rightor shift to the right 5. Gov’t spending increases5. 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 6. giant natural gas discovery decreases energy pricesprices or shift to the rightor shift to the right

7. cuts in tax rates increase incentives to save7. 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 8. low birth rate will decrease the labor force in the future.the future. NC—will not affect aggregate supply for 16 years or NC—will not affect aggregate supply for 16 years or

more—we graph for TODAY. more—we graph for TODAY. Any questions?Any questions?

Long Run Aggregate SupplyLong Run Aggregate Supply

PL

Output or GDPr

LRAS

Represents the Q of g & s a nation can Represents the Q of g & s a nation can produce over a sustained period of time produce over a sustained period of time using its productive resources efficientlyusing its productive resources efficiently

LRAS is at full employmentLRAS is at full employment 4 factors of production will shift the LRAS4 factors of production will shift the LRAS