Short Run Aggregate Supply

9 Key excerpts on "Short Run Aggregate Supply"

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  eBook - ePub

  Economics

  The Definitive Encyclopedia from Theory to Practice [4 volumes]

  • David A. Dieterle(Author)
  • 2017(Publication Date)
  • Greenwood

    (Publisher)

  Aggregate supply (AS) shows how changes in both short-run aggregate supply (SRAS) and long-run aggregate supply (LRAS) impact both the price level and real GDP. LRAS is composed of the productive capacity of an economic system or the production possibilities frontier, which is bound to the quantities of the factors of production and technology. SRAS is bound to the prices of the factors of production.

  The SRAS curve is upward-sloping because as prices increase, producers are more willing to supply goods and services (law of supply). The LRAS curve is vertical: a constant that is fixed to the quantity of the factors of production and technology or the production possibilities frontier.

  LRAS and SRAS are sensitive to changes in the quantities of the factors of production and technology. When there are more productive resources or an increase in technology, the LRAS and SRAS curves will increase or shift to the right in the AD/AS model, which will increase GDP and decrease the overall price level. The SRAS curve is sensitive to changes in the prices of the factors of production or temporary disruption in a supply-chain of an essential good, such as oil, and expectations about future inflation (this is really producers reacting to what they believe it will cost to replace their inventories). If the prices of the factors of production increase, or if producers expect future inflation, producers will supply less because it will be more costly to produce (some producers will exit the market) and the SRAS cure will shift to the left, resulting in an increase in the overall price level and a short-run decrease in real GDP. This combination of an increase in the overall price level and a short-run decrease in real GDP, called stagflation, is very difficult for the Federal Reserve or the government to cure.

  Figure 2. Short-run and long-run aggregate supply curves

  Many economists believe that the best way to combat stagflation is to wait until the prices of the factors of production adjust back down or the disruption in the supply chain is remedied. Conversely, if there is a decrease in the prices of the factors of production or if producers expect lower inflation in the future, SRAS will increase (more suppliers will enter the market) because it is cheaper to produce, which results in a decrease in the overall price level and a short-run increase in real GDP.

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  eBook - PDF

  Principles of Macroeconomics 3e

  • David Shapiro, Daniel MacDonald, Steven A. Greenlaw(Authors)
  • 2022(Publication Date)
  • Openstax

    (Publisher)

  A shift in the SRAS curve to the right will result in a greater real GDP and downward pressure on the price level, if aggregate demand remains unchanged. However, if this shift in SRAS results from gains in productivity growth, which we typically measure in terms of a few percentage points per year, the effect will be relatively small over a few months or even a couple of years. Recall how in Choice in a World of Scarcity, we said that a nation's production possibilities frontier is fixed in the short run, but shifts out in the long run? This is the same phenomenon using a different model. How Changes in Input Prices Shift the AS Curve Higher prices for inputs that are widely used across the entire economy can have a macroeconomic impact on aggregate supply. Examples of such widely used inputs include labor and energy products. Increases in the price of such inputs will cause the SRAS curve to shift to the left, which means that at each given price level for outputs, a higher price for inputs will discourage production because it will reduce the possibilities for earning profits. Figure 11.7 (b) shows the aggregate supply curve shifting to the left, from SRAS 0 to SRAS 1 , causing the equilibrium to move from E 0 to E 1 . The movement from the original equilibrium of E 0 to the new equilibrium of E 1 will bring a nasty set of effects: reduced GDP or recession, higher unemployment because the economy is 11.3 • Shifts in Aggregate Supply 281 now further away from potential GDP, and an inflationary higher price level as well. For example, the U.S. economy experienced recessions in 1974–1975, 1980–1982, 1990–91, 2001, and 2007–2009 that were each preceded or accompanied by a rise in the key input of oil prices. In the 1970s, this pattern of a shift to the left in SRAS leading to a stagnant economy with high unemployment and inflation was nicknamed stagflation.

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  Principles of Economics 3e

  • Steven A. Greenlaw, David Shapiro, Daniel MacDonald(Authors)
  • 2022(Publication Date)
  • Openstax

    (Publisher)

  A shift in the SRAS curve to the right will result in a greater real GDP and downward pressure on the price level, if aggregate demand remains unchanged. However, if this shift in SRAS results from gains in productivity growth, which we typically measure in terms of a few percentage points per year, the effect will be relatively small over a few months or even a couple of years. Recall how in Choice in a World of Scarcity, we said that a nation's production possibilities frontier is fixed in the short run, but shifts out in the long run? This is the same phenomenon using a different model. How Changes in Input Prices Shift the AS Curve Higher prices for inputs that are widely used across the entire economy can have a macroeconomic impact on aggregate supply. Examples of such widely used inputs include labor and energy products. Increases in the price of such inputs will cause the SRAS curve to shift to the left, which means that at each given price level for outputs, a higher price for inputs will discourage production because it will reduce the possibilities for earning profits. Figure 24.7 (b) shows the aggregate supply curve shifting to the left, from SRAS 0 to SRAS 1 , causing the equilibrium to move from E 0 to E 1 . The movement from the original equilibrium of E 0 to the new equilibrium of E 1 will bring a nasty set of effects: reduced GDP or recession, higher unemployment because the economy is 24.3 • Shifts in Aggregate Supply 591 now further away from potential GDP, and an inflationary higher price level as well. For example, the U.S. economy experienced recessions in 1974–1975, 1980–1982, 1990–91, 2001, and 2007–2009 that were each preceded or accompanied by a rise in the key input of oil prices. In the 1970s, this pattern of a shift to the left in SRAS leading to a stagnant economy with high unemployment and inflation was nicknamed stagflation.

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  Economics

  A Contemporary Introduction

  • William A. McEachern(Author)
  • 2016(Publication Date)
  • Cengage Learning EMEA

    (Publisher)

  Short-Run Aggregate Supply In the short run, prices may rise faster than costs. This chapter discusses why this might happen. Suppose that labor and management agree to adjust wages continuously for any changes in the price level. How would such adjustments affect the slope of the aggregate supply curve? 2. Potential Output Define the economy’s potential output. What factors help determine potential output? 3. Actual Price Level Higher than Expected Discuss some instances in your life when your actual production for short periods exceeded what you considered your potential, or normal, production. Why does this occur only for brief periods? 4. Nominal and Real Wages Complete each of the following sentences: a. The _______ wage measures the wage rate in dollars of the year in question, while the _______ wage measures it in con- stant dollars. b. Wage agreements are based on the _______ price level and negotiated in _______ terms. Real wages are then deter- mined by the _______ price level. c. The higher the actual price level, the _______ is the real wage for a given nominal wage. d. If nominal wages are growing at 2 percent per year while the annual inflation rate is 3 percent, then real wages change by _______. 5. Recessionary Gaps After reviewing Exhibit 3 in this chapter, explain why recessionary gaps occur only in the short run and only when the actual price level is below what was expected. 6. Short-Run Aggregate Supply In interpreting the short-run aggregate supply curve, what does the adjective short-run mean? Explain the role of labor contracts along the SRAS curve. 7. Recessionary Gap What does a recessionary gap imply about the actual rate of unemployment relative to the natural rate? What does it imply about the actual price level relative to the expected price level? What must happen to real and nominal wages in order to close a recessionary gap? 8.

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  A Primer on Macroeconomics

  Policies and Perspectives

  • Thomas M. Beveridge(Author)
  • 2018(Publication Date)
  • Business Expert Press

    (Publisher)

  At point B, the opposite environment exists. Production level is low and the unemployment rate exceeds the natural rate of unemployment. Unsold production is piling up in warehouses. Cyclically unemployed workers, desperate for a job, may be willing to accept lower wages and reduced benefits. Other resources, sitting idle or underused, may become cheaper to acquire. In such a situation, productivity tends to increase, as workers who still have a job strive to avoid layoffs. Declining resource costs and increasing productivity will push the SRAS curve to the right.

  Conclusion : If the economy is in a situation similar to point B, then we would expect the underlying economic pressures to shift the SRAS curve to the right over time.

  At point E, the economy is neither overstressed nor underutilized. Labor and other resource markets are operating efficiently and sustainably, and firms have achieved their optimal inventory levels. There is no compelling pressure for change—the economy is at long-run equilibrium.

  Conclusion: Long-run equilibrium occurs at the aggregate price level where the SRAS curve and the LRAS curve intercept.

  The Self-Correcting Mechanism

  Let us suppose that the economy is initially at point E0 as shown in Figure 5.13 .

  The aggregate demand curve is AD0 , the short-run aggregate supply curve is SRAS0 , and the long-run aggregate supply curve is LRAS. The economy is in short-run and long-run equilibrium at point E0 .

  Now, perhaps because of increasing consumer and business confidence, aggregate demand shifts to AD 1 . At the initial price level, P 0 , there will be a mismatch between aggregate demand and short-run aggregate supply,

  with declining inventories and swelling waiting lists for orders. The aggregate price level will start to increase. Following the short-run equilibrating process described in the previous section, the economy will achieve a new short-run equilibrium at point A. At this point, the economy is producing at an output level, y

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  eBook - PDF

  Macroeconomics as a Second Language

  • Martha L. Olney(Author)
  • 2011(Publication Date)
  • Wiley

    (Publisher)

  Again, higher input costs would lead businesses to raise output prices. But here, higher input costs are due to decreased supplies of inputs. For any level of output supplied, higher input costs would cause output prices to rise. Higher input costs due to decreased supply of inputs shifts the SRAS curve up. Shifts of the aggregate supply curve are illustrated in Figure 14.8. To summa- rize the factors that can shift aggregate supply: ↑Quantities of inputs → shift LRAS and SRAS to the right ↓Quantities of inputs → shift LRAS and SRAS to the left ↑Productivity of inputs → shift LRAS and SRAS to the right ↓Productivity of inputs → shift LRAS and SRAS to the left ↑Costs of inputs → shift SRAS up (equivalently, to the left) ↓Costs of inputs → shift SRAS down (equivalently, to the right) SRAS 2 Real GDP Average price level (P) LRAS 2 Old GDP potential New GDP potential SRAS 1 LRAS 1 Figure 14.8 Shifts of the Aggregate Supply Curves. A change in the average level of output prices or in GDP supplied moves us along an exist- ing SRAS curve. An increase in quantities of inputs or in the productivity of inputs shifts both the LRAS and the SRAS curves to the right. 256 Chapter 14 Inflation and Output: The AS/AD Approach TRY 13. For each of the following events, what is its effect on the LRAS and SRAS curves? a. Labor force grows b. Amount of capital in the economy increases c. Labor productivity rises d. The price of energy rises AS /AD EQUILIBRIUM Aggregate demand is the set of combinations of average price level and planned aggregate expenditure, C + I + G + NX . At a higher average price level, planned aggregate expenditure is lower due to the interest rate, wealth, and foreign trade effects. The aggregate demand curve slopes down. Aggregate supply is the set of combinations of average price level and amount of output businesses want to produce, GDP supplied. At a higher average price level, firms produce more output in the short run.

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  eBook - ePub

  Economics For Dummies

  Book + Chapter Quizzes Online

  • Sean Masaki Flynn(Author)
  • 2023(Publication Date)
  • For Dummies

    (Publisher)

  * . There is neither a surplus nor a shortage that could cause prices to change.

  The SRAS curve is horizontal at price

  P0

  to reflect the fact that after the economy reaches its equilibrium (where

  AD0

  intersects the LRAS at output level

  Y*

  ), the prices that are determined at that level are fixed in the short run; they can’t change immediately, even if a demand shock happens to come along.

  For instance, suppose that the aggregate demand curve shifts left from

  AD0

  to

  AD1

  because of a negative demand shock of some sort. Because prices are fixed in the short run at

  P0 ,

  the economy’s first response is to move from Point A to Point B. In other words, because prices are fixed, production falls from

  Y*

  down to

  YLow

  as firms respond to decreased demand by cutting production. (Small arrows indicate the movement of the economy from Point A to Point B. )

  © John Wiley & Sons, Inc.

  FIGURE 16-5: Short-run and long-run responses to a negative demand shock.

  At Point B, the economy is operating below full employment, implying that a lot of workers are unemployed. This high level of unemployment causes wages to fall. As wages fall, firms’ costs also fall, allowing them to cut prices to attract more customers.

  Falling prices cause increased aggregate demand for goods and services, which eventually moves the economy all the way from Point B to Point C . (Arrows on the graph indicate this movement.) When the economy reaches point C, it’s once again producing at full employment,

  Y*

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  eBook - ePub

  Macroeconomics For Dummies

  • Dan Richards, Manzur Rashid, Peter Antonioni(Authors)
  • 2016(Publication Date)
  • For Dummies

    (Publisher)

  Chapter 10 for details). In the short run, the interaction of aggregate supply and aggregate demand determines how much a country produces (GDP) and how much on average those goods will cost to purchase (the price level), as well as how fast that price level is changing (inflation), plus how much unemployment an economy experiences.

  Looking at long-run aggregate supply

  Economists distinguish between the short run and the long run because the economy behaves in a different way depending on the time frame you’re looking at. The important thing about the long run is that prices are fully flexible (they can change a lot), whereas in the short run prices are sticky (they don’t change by very much — check out the later section “Pulling apart why prices can be sticky ” for some suggested causes of this stickiness).

  Saying that prices are sticky is a way of saying something important about the behavior of suppliers. When demand for any product increases, the businesses that make those goods can do one of three things:

  • Hold output constant and raise their price until the extra demand is choked off
  • Hold the price constant and increase supply enough to meet all the new demand
  • Do a bit of both

  The same options arise for the workers, who supply labor, and the capitalists who supply capital to the firms. In response to a rising demand for their services, they can supply more labor and capital services, raise their compensation demands, or, again, do some of both.

  In the long run, it’s the first option that best describes agents’ behavior in a macro sense. Given enough time, a rise in demand leads to a higher overall aggregate price level P (and higher wages, too) but no more output. In the short run, it’s the second choice that rules. Initially, prices and wages are held in check in response to a demand shock. The result is that, in the short run, a rise in demand evokes mostly an increase in production, whereas a fall in demand induces production to fall. In this section, we review briefly the long-run supply behavior, which is really what the growth model of Chapter 8

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  eBook - PDF

  Demystifying Global Macroeconomics

  • John E. Marthinsen(Author)
  • 2020(Publication Date)
  • De Gruyter

    (Publisher)

  Operating in prosperous, swiftly moving nations is like swimming in a rapidly moving stream because it makes increased sales volume easier to achieve and price hikes easier to implement. When companies operate in countries with infla-tionary climates, price increases are necessary just to keep even in real terms. What causes short-run changes in a nation ’ s average price level (i.e., GDP Price Index) and output (i.e., real GDP)? What happens to the GDP Price Index and real GDP when oil prices rise due to an embargo, war in the Middle East, or in-creased demand by China and India? Are there economic differences when prices rise due to increasing costs as opposed to increasing demand? What is the relation-ship between a nation ’ s unemployment rate and GDP Price Index? How can com-panies factor these changes into their financial planning? This chapter addresses these questions using the aggregate supply and aggregate demand framework. The Basics Aggregate Supply Curve The aggregate supply (AS) curve shows the quantity of domestically produced goods and services that firms are willing and able to produce and sell at various average national price levels during a given period. A nation ’ s average price level is just another name for the GDP Price Index (P), and as Figure 12.1 shows, https://doi.org/10.1515/9781547401437-012 it is placed on the vertical axis of the aggregate supply graph, with real gross domestic product (RGDP) placed on the horizontal axis. The curvature of the aggregate supply curve shown in Figure 12.1 is easiest to understand if we separate it into three ranges, which are the Keynesian range, classical range, and intermediate range. Keynesian Range The horizontal portion of aggregate supply is called the Keynesian range , where a nation ’ s real GDP is extremely low (depression-like), unemployment is very high, and companies have plenty of excess capacity.

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