The Long-Run Aggregate Supply Curve

12 Key excerpts on "The Long-Run Aggregate Supply Curve"

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  eBook - ePub

  Economics for Investment Decision Makers

  Micro, Macro, and International Economics

  • Christopher D. Piros, Jerald E. Pinto(Authors)
  • 2013(Publication Date)
  • Wiley

    (Publisher)

  To understand what price and output level will prevail in the economy, we need to add aggregate supply, the amount of output producers are willing to provide at various prices. The aggregate supply curve (AS curve) represents the level of domestic output that companies will produce at each price level. Unlike the demand side, we must distinguish between the short- and long-run AS curves, which differ with respect to how wages and other input prices respond to changes in final output prices. Long run and short run are relative terms and are necessarily imprecise with respect to calendar time. The long run is long enough that wages, prices, and expectations can adjust but not long enough that physical capital is a variable input. Capital and the available technology to use that capital remain fixed. This condition implies a period of at least a few years and perhaps a decade. The truly long run in which even the capital stock is variable may be thought of as covering multiple decades. Consideration of the very long run is postponed to our discussion of economic growth in Section 4. In the very short run, perhaps a few months or quarters, companies will increase or decrease output to some degree without changing price. This is shown in Exhibit 5-14 by the horizontal line labeled VSRAS (very short-run aggregate supply). If demand is somewhat stronger than expected, companies earn higher profit by increasing output as long as they can cover their variable costs. So they will run their plants and equipment more intensively, demand more effort from their salaried employees, and increase the hours of employees who are paid on the basis of hours worked

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  Macroeconomics

  • William Boyes, Michael Melvin(Authors)
  • 2015(Publication Date)
  • Cengage Learning EMEA

    (Publisher)

  At this point, increases in the price level bring about smaller and smaller increases in output from firms as a whole. The short-run aggregate supply curve becomes increasingly steep as the economy approaches maximum output. 8-4b-2 Long-Run Aggregate Supply Curve Aggregate supply in the short run is dif-ferent from aggregate supply in the long run (see Figure 11). That difference stems from the fact that, in the long run, quantities and costs of resources are not fixed. Over time, contracts expire, and wages and other resource costs adjust to current conditions. The increased flexi-bility of resource costs in the long run has costs rising and falling with the price level and changes the shape of the aggregate supply curve. Lack of information about economic condi-tions in the short run also contributes to the inflexibility of resource prices as compared to the long run. The Economic Insight “How Lack of Information in the Short Run Affects Wages in the Long Run” shows why this is true for labor, as well as for other resources. The Long-Run Aggregate Supply Curve ( LRAS ) is viewed by most economists as being a vertical line at the potential level of real GDP or output ( Y p ), as shown in Figure 11. Remember that the potential level of real GDP is the income level that is produced in the absence of any cyclical unemployment, or when the natural rate of unemployment exists. In the long run, wages and other resource costs fully adjust to price changes. The short-run AS curve slopes upward because we assume that the costs of production, particularly FIGURE 9 Aggregate Supply Price Level P 1 Real GDP (dollars) 700 100 600 200 500 300 400 0 P 0 AS The aggregate supply curve shows the amount of real GDP produced at different price levels. The AS curve slopes up, indicating that the higher the price level, the greater the quantity of output produced.

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  Economics

  A Contemporary Introduction

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

    (Publisher)

  The Long-Run Aggregate Supply Curve depends on the supply of resources in the economy, the level of technology and know-how, and the production incentives provided by the formal and informal institutions of the economic system. In Exhibit 4, the initial price level of 110 is determined by the intersection of AD with The Long-Run Aggregate Supply Curve. If the aggregate demand curve shifts out to AD, then in the long run, the equilibrium price level increases to 120 but equilibrium output remains at $17.0 trillion, the economy’s potential GDP. Conversely, a decline in aggre- gate demand from AD to AD0, in the long run, leads only to a fall in the price level from long-run aggregate supply (LRAS) curve A vertical line at the economy’s potential output; aggregate supply when there are no surprises about the price level and all resource contracts can be renegotiated expected price level of 100. Because the expected price level and the actual price level are now identical, the economy is in long-run equilibrium at point e. Although the nominal wage is lower at point e than that originally agreed to when the expected price level was 110, the real wage is the same at point e as it was at point a. Because the real wage is the same, the amount of labor that workers supply is the same and real output is the same. All that has changed between points a and e are nominal measures—the price level, the nominal wage, and other nominal resource prices. We conclude that when incorrect expectations cause firms and resource suppliers to overestimate the actual price level, output in the short run falls short of the economy’s potential. As long as wages and prices are flexible enough, however, firms and workers should be able to renegotiate wage agreements based on a lower expected price level. The negotiated drop in the nominal wage shifts the short-run aggregate supply curve to the right until the economy once again produces its potential output.

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  Macroeconomics

  (With Study Guide CD-ROM)

  • Jagdish Handa(Author)
  • 2010(Publication Date)
  • WSPC

    (Publisher)

  y*) = 0. However, we cannot take it for granted that the real-world economies will meet these assumptions for each period of our study, when these periods are as short as, say, a month, a quarter, or a year. We, therefore, resorted to the analytical notion of the long run, which is defined as the stage in which these assumptions are met, so that the economy can be said to be at the full-employment (LR) level of output.

  Hence, the aggregate supply curve for the full-employment level of output is called the LR aggregate supply (LRAS) curve. It is applicable in the case of zero expectational errors, zero adjustment costs and lags, and equilibrium in the labor market and in production. It is strictly not applicable when these conditions are not met. However, the LR levels of output and employment can be used as a benchmark or reference state toward which the economy will tend to move. If it does not do so of its own volition or does not do so fast enough, macroeconomics (see Chapters 8 and 9 ) examines the policies that can induce such a movement.

  7.11.1 Changes in the actual rate of output over time

  The actual level of output alters over time because of changes in any or all of its three components since:

  As we have argued earlier, the full-employment level of output does change over time due to shifts in technology and in labor supply. The other two components of the actual level can also change and do change over the business cycle. In particular, they are positively related to the business cycle and tend to have positive values during a boom than during a recession. They can be changed by monetary and fiscal policies.

  7.12 The Rate of Unemployment

  This chapter has focused on the long-run analysis of output and employment. Changes in unemployment and its rate are the converse of those in employment, so that we now derive the implications of the long-run analysis for unemployment. Chapter 10

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  eBook - PDF

  21st Century Economics: A Reference Handbook

  • Rhona C. Free(Author)
  • 2010(Publication Date)
  • SAGE Publications, Inc

    (Publisher)

  It is vertical because, in the long run, real GDP is determined by real forces such as the availability of resources and technology, not by the price level. Over time, The Long-Run Aggregate Supply Curve will shift right as technology improves and as the economy acquires more capital and labor. Its position is also affected by tax rates and other things that affect the incentives to supply capital and labor, create businesses, and develop new technology. Deviations from full employment can occur when the actual price level deviates from the expected price level. There is no consensus as to why this is the case, but three differ-ent explanations are commonly presented (Mankiw, 2007). S R A S 2 (Expected Ρ = P 2 ) S R A S ! (Expected Ρ = Pi) Figure 32.2 The Enhanced AD/AS Model SOURCE: Adapted from Mankiw (2007, p. 762). One explanation, called the sticky-wage model, is based on the idea that wages are not perfectly flexible and may be fixed in the short run. Wages are set based on some expected price level, so if prices turn out to be higher than expected, real wages will be lower than expected. In response, firms will hire more workers and increase output. In other words, the aggregate supply curve will have a positive slope in the short run. The effect will not persist, however, because nominal wages will eventually adjust to reflect the higher level of prices. When price expectations are adjusted upward, workers will demand higher wages. Employment will then return to its long-run value. In terms of the model, the short-run aggregate supply curve will shift left (see Figure 32.2). Another explanation for the short-run aggregate supply curve's positive slope begins with the observation that many prices are sticky. That means that some firms change their prices only periodically. The prices of raw commodities like grain and metal may fluctuate daily, or even hourly, but prices of finished goods behave differently.

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  Macroeconomics

  Principles & Policy

  • William Baumol, Alan Blinder, John Solow, , William Baumol, Alan Blinder, John Solow(Authors)
  • 2019(Publication Date)
  • Cengage Learning EMEA

    (Publisher)

  Puzzle Copyright 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. 194 Part 2 The Macroeconomy: Aggregate Supply and Demand 10-1 THE AGGREGATE SUPPLY CURVE In earlier chapters, we noted that aggregate demand is a schedule, not a fixed number. The idea that the quantity of real gross domestic product (GDP) that will be demanded depends on the price level is summarized in the economy’s aggregate demand curve. Precisely the same point applies to aggregate supply: The concept of aggregate supply does not refer to a fixed number, but rather to a schedule—an aggregate supply curve. The volume of goods and services that profit-seeking enterprises provide depends on the prices they obtain for their outputs, on wages and other production costs, on the capital stock, on the state of technology, and on other things. The relationship between the price level and the quantity of real GDP supplied, holding all other determinants of quantity supplied constant, is called the economy’s aggregate supply curve. Figure 1 shows a typical aggregate supply curve. It slopes upward, meaning that as prices rise, more output is produced, other things held constant. Let’s see why. 10-1a Why the Aggregate Supply Curve Slopes Upward Most producers are motivated by profit. The profit made by producing and selling an additional unit of output is simply the difference between the price at which it is sold and the unit cost of production: 5 2 Unit profit Price Unit cost.

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  Economics For Dummies, UK Edition

  • Peter Antonioni, Sean Masaki Flynn(Authors)
  • 2010(Publication Date)
  • For Dummies

    (Publisher)

  curve slopes downward. That’s because an inverse relationship exists between the price level and the amount of stuff that people want to buy. Inverse relationship simply means that at the higher price level (P High ) , people want to buy a low level of output (Y Low ) . But if prices fall to P Low , people demand a much greater amount of output (Y High ) . The downward slope of the AD curve captures the fact that at lower prices, people buy more.

  The long-run aggregate supply curve represents the amount of goods and services that an economy is going to produce when prices have adjusted after an economic shock.

  In Figure 6-2, you can see that the LRAS is a vertical line – it isn’t a curve at all! (If you feel cheated, remember that a straight line is just a special type of curve, one without any curvature!) The LRAS is drawn above the point on the horizontal axis that represents the full-employment output level, Y * . Why? Because in the long run, changes in prices always return the economy to producing at the full-employment output level.

  Still don’t believe us? You are a sceptical bunch. We’re going to convince you, but first you have to pay attention because here comes the science. The Tao of P: Looking at price adjustments in the long run

  Examine what happens if the economy starts out at a price level other than P * . For example, look again at price level P High and its corresponding aggregate demand level, Y Low . Obviously, Y Low is less than the economy’s full-employment level of output (Y * ). That’s important because firms would rather produce at output level Y * .

  In fact, they’ve invested in factories and equipment that will be wasted if they produce at lower levels of output. Consequently, their response is to cut prices in order to increase sales. And they continue to cut prices until the overall price level in the economy falls down to

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  Economics

  Principles & Policy

  • William Baumol, Alan Blinder, John Solow, , William Baumol, Alan Blinder, John Solow(Authors)
  • 2019(Publication Date)
  • Cengage Learning EMEA

    (Publisher)

  Puzzle Copyright 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. 554 Part 6 The Macroeconomy: Aggregate Supply and Demand 26-1 THE AGGREGATE SUPPLY CURVE In earlier chapters, we noted that aggregate demand is a schedule, not a fixed number. The idea that the quantity of real gross domestic product (GDP) that will be demanded depends on the price level is summarized in the economy’s aggregate demand curve. Precisely the same point applies to aggregate supply: The concept of aggregate supply does not refer to a fixed number, but rather to a schedule—an aggregate supply curve. The volume of goods and services that profit-seeking enterprises provide depends on the prices they obtain for their outputs, on wages and other production costs, on the capital stock, on the state of technology, and on other things. The relationship between the price level and the quantity of real GDP supplied, holding all other determinants of quantity supplied constant, is called the economy’s aggregate supply curve. Figure 1 shows a typical aggregate supply curve. It slopes upward, meaning that as prices rise, more output is produced, other things held constant. Let’s see why. 26-1a Why the Aggregate Supply Curve Slopes Upward Most producers are motivated by profit. The profit made by producing and selling an additional unit of output is simply the difference between the price at which it is sold and the unit cost of production: 5 2 Unit profit Price Unit cost.

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  Macroeconomics

  Principles and Policy

  • William Baumol, Alan Blinder(Authors)
  • 2015(Publication Date)
  • Cengage Learning EMEA

    (Publisher)

  This chapter took the next step by showing how shifts in the aggregate demand curve cause fluctuations in both real GDP and prices—fluctuations that are widely decried as undesirable. It also sug-gested that the economy’s self-correcting mechanism works, but slowly, thereby leaving room for government stabilization policy to improve the workings of the free market. Can the government really accomplish this goal? If so, how? These are some of the important questions for Part 3. Copyright 2016 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. Chapter 10 Bringing in the Supply Side: Unemployment and Inflation? 211 1. The economy’s aggregate supply curve relates the quantity of goods and services that will be supplied to the price level. It normally slopes upward to the right because the costs of labor and other inputs remain relatively fixed in the short run, meaning that higher selling prices make input costs relatively cheaper and therefore encourage greater production. 2. The position of the aggregate supply curve can be shifted by changes in money wage rates, prices of other inputs, technology, or quantities or qualities of labor and capital. 3. The equilibrium price level and the equilibrium level of real GDP are jointly determined by the intersec-tion of the economy’s aggregate supply and aggregate demand schedules. 4. Among the reasons why the oversimplified multiplier formula is wrong is the fact that it ignores the inflation that is caused by an increase in aggregate demand. Such inflation decreases the multiplier by reducing both consumer spending and net exports.

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  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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  Macroeconomics in Emerging Markets

  • Peter J. Montiel(Author)
  • 2011(Publication Date)
  • Cambridge University Press

    (Publisher)

  Thus full-employment GDP is given by Y P = AF ( K , L P , ) (4.2) Short-run macroeconomics is typically concerned with stabilization of employment around its full-employment level, the determination of the average price level in the economy, and the behavior of various components of the economy’s balance of payments. The long run, by contrast, is a period of time long enough that the capital stock and state of technological knowledge can change endogenously . Long-run macroeconomics is primarily concerned with what determines how the level of the economy’s productive capacity changes over time. As we saw in the preceding chapter, increases in economic capacity are what we refer to when we use the term economic growth . Notice that this means that growth does not just refer to an increase in real GDP but to an increase in productive capacity , whether that capacity is used or not. It is useful to clarify the distinction algebraically. Using the aggregate production function, we can approximate the change in (actual) output during any given period of time as the sum of contributions made by each of the three arguments in the production function, where the contribution of each is the change in that argument multiplied by its marginal product, Y = F A + MP K K + MP L L because MP A , the marginal product of A , is just F . Dividing through by Y , and noting that AF / Y = 1, Y / Y = A / A + MP K ( K / Y ) K / K + MP L ( L / Y ) L / L 5 (4.3) Recalling that for any variable X , X / X is just the rate of growth of X , this equation states that the growth of Y depends on the rates of growth of total factor productivity, of the stock of physical capital, and of labor. An equation such as this is often used by economists to decompose growth into the contributions of factor accumulation and improvements in TFP, in an exercise referred to as growth accounting .

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  Foundations of Macroeconomics

  Its Theory and Policy

  • Frederick S. Brooman(Author)
  • 2017(Publication Date)
  • Routledge

    (Publisher)

  CHAPTER 10Prices, Wages, and Aggregate Supply

       

  1. The Aggregate Supply Curve

  In the last five chapters, the various components of aggregate demand – consumption, investment, government spending, exports, and (negatively) imports – have been examined in detail, especially with regard to their relationship with current real income. It was found that consumption depends partly on income and partly on such other factors as consumers’ assets and liabilities; that investment may be influenced to a small extent by current income but depends much more on firms’ expectations of future profit, on past changes in income, and on the cost of financing new projects; that government spending, being largely determined by political decisions about such matters as the necessary scale of defense expenditure, is essentially autonomous of current income; and that, while imports can be expected to vary with income to some degree, exports are affected only indirectly through the feedback described in Chapter 8 . In the light of all these findings, the original “equilibrium equation”

  C + I + G + E – M

  has been amplified and extended in various ways so as to bring in the marginal propensities to consume, import, and invest; to allow for the effects of taxation; to introduce additional variables such as income from previous periods, and so on.

  Obviously the equation could be expanded and elaborated still further along these lines. However, the fact remains that, as it stands, the “equilibrium condition” is subject to a serious limitation – namely, that because all quantities are stated in real terms, it throws no light on the determination of the general price level. Yet the behavior of prices is of great interest and importance to individuals, business firms, and governments. Large and sudden changes can be highly disruptive – impoverishing or enriching people according to whether they happen to be debtors or creditors, upsetting normal economic calculations, and creating uncertainties that inhibit the rational use of resources. Even where governments aim at minimum interference with the working of the economy, they usually attempt to maintain reasonable price stability through monetary policy. No theory of the working of the economy as a whole can be complete, therefore, unless it explains the determination of the general price level as well as the volume of “real” output. A full explanation will not be possible until money

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