Download Fina 353-Lecture Slide Week 8

ECON203
Principles of Macroeconomics
Week 8
Topic: Aggregate Supply
Dr. Mazharul Islam
1
Learning outcomes for
student revision
To learn about
After studying these topics you should be able to:
 Understand the meaning and factors that affect
Aggregate Supply (AS or SAS)
 Explain the meaning and differences between
Equilibrium output (Ye) and Potential output (YP) and
why and how they will change
 Show changes using an AS graph and explain their
output and price implications
Dr. Mazharul Islam
2
Aggregate Supply
Aggregate Supply is the total amount of final goods (G)
and services (S) that firms in the country plan on selling
during a specific time period.
 The aggregate quantity of G&S supplied depends on
5 factors → quantity of labour (L ), Land and natural
resources, Entrepreneurial talent, quantity of
capital (K ), technology (T )
Dr. Mazharul Islam
3
Aggregate Supply
Aggregate Supply shows the relationship
between the price level and quantity of real GDP
supplied.
Short-run Aggregate Supply (SAS) is the
relationship between the quantity of real GDP
supplied and the output price level when factor
prices (and potential GDP) are constant.
– In the short-run: As prices rise producers are willing
to increase quantity supplied (move along SAS) and
employ more labour.
Dr. Mazharul Islam
4
SAS
Other things remaining the same, the higher the price
level, the greater the quantity of real GDP supplied ,
and the lower the price level, the smaller the quantity
of real GDP supplied.
Price level ( GDP Price Index )
2005=100
Quantity of real GDP supplied
Trillions of 2005 dollars
E
120
14.0
D
115
13.5
C
110
13.0
B
105
12.5
A
100
12.0
P
Dr. Mazharul Islam
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Changes in Aggregate Supply
in Short Run.
GPL
125
SAS
115
105
95
85
0
860
880
900
920
940
Real GDP
Dr. Mazharul Islam
6
Why the AS Curve Slopes
Upward?
The answer is:
If the price level rises , firms will increase the
quantity of labor employed and the level of
production (assuming money wages constant).
Why?
• To change its output rate, a firm must change the
quantity of labor that it employs. If the additional
labor costs less than the revenue the firm generates,
it is profitable to hire more labor otherwise
unprofitable.
Dr. Mazharul Islam
7
Why the AS Curve Slopes
Upward?
So if the price level rises and the money wage rate
doesn’t change (real wage rate decreases)  an extra
hour of labor becomes profitable and both the
quantity of labor demanded and production increase.
If the price level falls, firms will decrease the quantity
of labor employed and the level of production
(assuming money wages constant). Why?
 If the price level falls and the money wage rate doesn’t
change (real wage rate increases)  an extra hour of labor
becomes unprofitable and both the quantity of labor
demanded and production decrease.
Dr. Mazharul Islam
8
What is Real Wage Rate?
•
•
•
•
Real wage rate shows how much the money
wage rate buys goods and services.
The Real Wage Rate= the money wage rate
divided by the price level ( GDP price index)
If the money wage rate denoted by W and,
If the price level denoted by P
Then;
W
The Real Wage Rate 
P
Dr. Mazharul Islam
9
Why the AS Curve Slopes
Upward?
• So if the price level rises relative to wages,
profits increase, the number of firms in business
increase, and the quantity of real GDP supplied
as well as employment increases.
• And if the price level falls relative to wages,
profits decrease, the number of firms in
business decreases, and the quantity of real
GDP supplied
as well as employment
decreases.
Dr. Mazharul Islam
10
Changes in SAS (Shift of the
SAS curve)
• Aggregate supply changes when any influence
on production plans other than price level
changes.
Aggregate supply changes when:
1) Potential GDP changes (economic growth).
2) The money wage rate changes.
3) The money prices of other resources change.
Dr. Mazharul Islam
11
Changes in SAS (Shift of the
SAS curve)
Change in Potential GDP
• Anything that changes potential GDP changes
aggregate supply and shifts the aggregate
supply curve.
• If potential GDP increases then potential GDP
line and SAS curve shift to the right.
Dr. Mazharul Islam
12
Initial
new
Potential GDP Potential GDP
Price
Level
SAS1
130
SAS2
120
C
C”
110
100
90
0
12
13
Real GDP Supplied
14
15
Dr. Mazharul Islam
13
Changes in SAS (Shift of the
SAS curve)
Changes in Money Wage Rate
• A change in the money wage rate (nominal
wage) changes aggregate supply because it
changes firm’s costs.
• The higher the money wage rate, the higher are the
firms’ costs and the smaller is the quantity that
firms are willing to supply at each price level. It
does not affect the potential GDP. An increase in
money wage
a leftward (upward) shift of SAS
curve. In alternative situation, SAS shifts to the right
(downward)
Dr. Mazharul Islam
14
Potential GDP
Price
Level
SAS1
SAS0
D
120
110
SAS2
C
100
90
0 11.5 12
13
14
15
Real GDP
Dr. Mazharul Islam
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Changes in SAS (Shift of the
SAS curve)
Change in Money Prices of Other Resources
• A change in money prices of other inputs/resources
(such as Changes in world oil prices, Changes in the weather,
Technological change) has the same effect on firms’
production plans as a change in the money wage
rate. It changes firms’ costs.
• If the money prices of other resources rise, the price
level is the same, the real costs change and the quantity
that firms are willing to supply decreases at each price
level ( SAS shifts to the left ). In alternative situation,
SAS shifts to the right.
Dr. Mazharul Islam
16
Summary
Movements along the aggregate supply curves
– If output prices change but input prices do not,
we have a movement along the SAS curve.
– If both output and input prices change at the
same rate, then we have a movement along the
LAS curve.
Shifts of aggregate supply curves
When anything other than a change in real GDP or price
level, SAS curve itself shifts. Such as
– Changes in prices of other resources (such as world
oil)
– Changes in the weather
– Technological change
– Nominal (money) wage rate
– Potential GDP
Dr. Mazharul Islam
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Now it’s over for
today. Do you have
any question?
Dr. Mazharul Islam
18