Aggregate Supply

Work Plan:
• Routine
• Attendance Checking
• Review
• Discussion
• Activity
• Feedbacking
• Wrap up
OBJECTIVE OF THE LESSON:
At the end of the lesson student must be able to:
• Describe the term ‘aggregate supply’
• Explain, using a diagram, why the short-run aggregate supply curve
(SRAS curve) is upward sloping.
• Explain, using a diagram, how the AS curve in the short run (SRAS)
can shift due to factors including changes in resource prices, changes
in business taxes and subsidies and supply shocksDetermine the
determinants of aggregate demand
The short run and long run in macroeconomics
The short run and the long run in macroeconomics differ from the
corresponding distinction in microeconomics.

• The short run in macroeconomics is the period of

time when prices of resources are roughly
constant or inflexible (they do not change much
in response to supply and demand). This applies
especially to wages, or the price of labor.

• The long run in macroeconomics is the period of

time when the prices of all resources, including
the price of labor (wages), are flexible and change
along with changes in the price level.
Aggregate Supply
• Aggregate supply is the total quantity of goods and
services produced in an economy (real GDP) over a
particular time period at different price levels.
• The short-run aggregate supply curve (SRAS) shows the
relationship between the price level and the quantity of real
output (real GDP) produced by firms when resource prices
(especially wages) do not change.

Figure (a) illustrates a short-run aggregate

supply curve, indicating that there is a
positive (or direct) relationship between
the price level and real GDP supplied: a
higher price level is associated with a
greater quantity of real GDP, and a lower
price level with a lower quantity of real
GDP.
Why the SRAS curve is upward-sloping?
• The explanation for the positive relationship between the price level
and real output (real GDP) is based on fi rm profitability: when there
is an increase in the price level, this means that output prices have
increased; but with unchanging resource prices (since the economy is
in the short run), fi rms’ profits increase.

• As production becomes more profitable, fi rms increase the quantity

of output produced, resulting in the positive relationship between the
price level and the quantity of real GDP supplied.
 Changes in short-run aggregate supply (shifts
in the SRAS curve)
• A change in the price level leads to a
movement on the SRAS curve. A number
of factors (other than the price level)
cause shifts of the SRAS curve, illustrated
in Figure (b).

A rightward shift from SRAS1 to SRAS2 means

that short-run aggregate supply increases: for any
particular price level, fi rms produce a larger
quantity of real GDP.
 Changes in short-run aggregate supply (shifts
in the SRAS curve)

A leftward shift from SRAS1 to SRAS3 means that

aggregate supply decreases: for any particular
price level, fi rms produce a smaller quantity of
real GDP.
 Important factors that cause SRAS curve shifts:
• changes in firms’ costs of production
• changes in taxes and subsidies,
• sudden events called ‘supply shocks’

Changes in wages.

If wages increase, with the price level constant, firms’

costs of production rise, resulting in a leftward shift in
the SRAS curve, such as from SRAS1 to SRAS3 in Figure
(b).

If wages decrease, with the price level constant, firms’

costs drop, giving rise to a rightward shift in the SRAS
curve, such as from SRAS1 to SRAS2.
Changes in non-labour resource prices.
Changes in the price of non-labour resources,
such as the price of oil, equipment, capital
goods, land inputs, and so on affect the SRAS
curve in the same way as changes in wages. An
increase in the price of a resource shifts the
SRAS curve to the left; a decrease shifts it to
the right.
Changes in business taxes.

Business taxes are taxes on firms’ profits, and

are treated by firms like costs of production.
Therefore, higher taxes on profits are like
increases in production costs and so shift the
SRAS curve to the left. Lower taxes on profits
are like lower production costs and shift the
SRAS curve to the right.
Changes in subsidies offered to businesses.

Subsidies have the opposite effect to taxes, as

they involve money transferred from the
government to firms. If they increase, the
SRAS curve shifts to the right; if they decrease,
the SRAS curve shifts to the left.
Supply shocks.

Supply shocks are events that have a sudden and

strong impact on short-run aggregate supply.
Some supply shocks directly affect aggregate
supply.

For example, a war or violent conflict can result in

destruction of physical capital and disruption of
the economy, leading to lower output produced
and a leftward shift in the SRAS curve

Unfavorable weather conditions can cause a fall in

agricultural output, also shifting the SRAS curve to
the left.
(Determinants of Aggregate Supply)
Wages: This is the price of labor, which works through the
resource price determinant. It is the key determinant
underlying the self-correction mechanism of the aggregate
market. Wages affect the short-run aggregate supply
curve, but not the long-run aggregate supply curve.
(Determinants of Aggregate Supply)
Technology: Improvements in production techniques,
often embodied in product inventions and innovations, is a
prime example of a resource quality determinant.
Technology causes shifts in both the short-run and long-run
aggregate supply curves.
(Determinants of Aggregate Supply)
Energy Prices: These are the prices of key energy inputs, especially
petroleum, that are essential to any modern industrialized economy.
Like wages, energy prices also work through the resource price
determinant. Also like labor, energy prices affect the short-run
aggregate supply curve, but not the long-run aggregate supply curve.
(Determinants of Aggregate Supply)
Capital Stock: This is the total quantity of capital used by the
economy for production. It is a prime example of a resource
quantity determinant and affects both the short-run and long-run
aggregate supply curves.
Activity time!

Go to Moodle
Week 8
Section 8.5
and do the
given activity
posted there.