Aggregate Supply

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Aggregate Supply
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Aggregate Supply

• Aggregate supply is the quantity of aggregate
  output firms are willing and able to supply at
  different price levels in the economy, ceteris
  paribus
• Aggregate supply depends largely on the labor
  market.
• Why?
• Labor is the most important resource
• It accounts for about 70 of production costs
• Its the size and ability of labor that helps
  determine output

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Labor Supply and Wage Rate

• Labor Supply defined
• Wage Rate defined
• Labor Supply and the Wage Rate depends on
• Individual preferences for work versus leisure
• The size of the adult population and labor force
• The skills (productivity) of the adult population

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Demand and Supply in the Labor Market
Nominal wage rate
D
S
Millions of workers
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The Nominal Wage and the Real Wage

• The nominal wage and current dollars
• The real wage and constant purchasing power
• Workers and employers care more about the real
  wage than the nominal wage.

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Wages and Price Level Expectations

• Why are nominal wages important?
• Wage contracts and price level expectations

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Potential Output and the Natural Rate of
Unemployment

• Potential output is the economys maximum
  sustainable output level, given the supply of
  resources, technology, and the underlying
  economic institutions
• Potential Output and Unanticipated Inflation
• Natural rate of unemployment

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Potential Output Graphically Represented
(No Unanticipated Inflation)
Potential output
Price Level
Maximum sustainable output level, given the
supply of resources, technology, and the
underlying economic institutions
Potential GDP
Real GDP
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The Short Run

• The short run is a period during which some
  resources prices are fixed by agreement
• Aggregate supply, the short run and unexpected
  inflation and deflation

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Potential Output and the Short Run Aggregate
Supply
(No Unanticipated Inflation)
Potential output
Price Level
SRAS
Potential GDP
Max. GDP
Real GDP
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The Short-Run Supply Curve and The Price Level

• If the price level is higher than expected, the
  quantity supplied is above the economys
  potential output
• If the price level is lower than expected, the
  quantity supplied decreases
• As a result, there is a positive short-run
  relationship between the price level and
  aggregate output supplied

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The Actual Price Level is Higher Than Expected

• Firms experience higher profits, which stimulates
  the demand side of the labor market, pushing the
  economy past its potential output in the short
  run
• Workers will respond by supplying more labor due
  to
• Labor Contracts
• Large Pool of Unemployed Labor
• Workers and the price level
• Efficiency Wage
• In the long run, contract prices will rise,
  bringing the economy to potential output

13
The Actual Price Level is Lower Than Expected

• In this case, firms experience lower profits,
  which depresses the demand side of the labor
  market, pushing the economy below its potential
  output in the short run
• How will producers respond to an actual price
  level that is lower than expected?
• In the long run, contract prices will fall,
  bringing the economy to potential output.

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Long Run Supply Curve
In the long run, firms always return to the
potential level of output where all contracts
have been renegotiated and there are no price
surprises.
LRAS
Price Level
Potential output
Real GDP
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The Actual Price Level is Higher Than Expected
Potential output
AD
Price Level
SRAS
SRAS
Short-run equilibrium
Real GDP
expansionary gap
16
The Actual Price Level is Lower Than Expected
Potential output
Price Level
SRAS
AD
SRAS
Real GDP
contractionary gap
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Changes in Aggregate Supply

• Shifts in long run and short run aggregate supply
  are caused by
• Adverse supply shocks are unexpected events that
  reduce aggregate supply
• Beneficial supply shocks are unexpected events
  that reduce aggregate supply
• Supply of resources into production
• State of technology
• Laws and customs that shape the incentive to
  produce