Download PRESENTATION 2. Aggregate supply

Aggregate Supply
Frederick
University
2014
Long Run vs. Short Run from
a Macroeconomic Perspective
Long run period in macroeconomics
 the changes in the prices of production
factors and in the prices of final goods
and services are entirely synchronized
Short run in macroeconomics
 the changes in the prices are not
synchronized
Aggregate Supply (AS)
AS – the willingness and ability of
firms to produce GDP at every
price level, ceteris paribus
Deriving AS - short run
PPF and Potential GDP
1. The economy is in point U – high unemployment
And excess capacity – low AD. The firms would
Increase production at the current price level
(they do not need to be motivated by a price increase)
Physical PPF
А
W
V Institutional PPF
U
В
2. The economy moves to point V – due to the
law of diminishing returns МС start rising. The
firms would increase production if only their
buyers are willing to compensate them for the cost
increase. Since АС grow more slowly than МС
(short run and fixed cost), the increase in
production is faster than the increase in the price
level, i.е. production will increase faster than the
price level until it gets to point W
Deriving AS - short run
Potential GDP and AS
AS
Physical PPF
CPI
Z
Institutional PPF
W
Z
W
V
U
U
V
GDP
At point W the economy operates at full capacity, MRPL = MCL; any further increase in Real
production
will be accompanied by a faster increase in cost. The firms would increase production if only their buyers
are willing to compensate them for the cost increase – the price level will rise faster than output – the
AS Analysis – short run
AS segments in the short run:
1.
2.
3.
4.
5.
Horizontal Е = ∞ - from U to V – the firms are willing to
increase production at the current price level; the economy
operates at excess capacity
Shallow Е > from V to W – output rises faster than the price
level
E = 1 – point W – the economy operates at full capacity on
the Institutional PPF and produces potential GDP; the rate of
unemployment is equal to the natural rate
Steep E < 1 – from W to Z – the economy operates at
overcapacity – prices increase faster than output
Vertical Е = 0 – from Z – firms cannot increase output
whatever the price level is. The economic activity is on its
physical PPF
AS analysis – short run


Slope of the AS curve in the short run –
determined by the law of diminishing returns
and the price adjustment to cost increase
Short run – the macroeconomic perspective –
the period, during which, the changes in the
prices final goods and services and in the
prices of production factors are not
synchronized.
Factors, determining AS short run
Cost of production:
 Labor
cost – depends on education, traditions
(attitude to work and leisure), labor supply,
competitiveness
of
the
market
structure,
expectations, productivity
 Capital
cost – depends on the savings and
investment structure, raw material supplies,
technological changes, competitiveness of capital
markets
 Government policies – regulations, taxation, social
programs
 Foreign sector – barriers to international trade,
structure of the balance of payments
Macroeconomic Equilibrium –
short run
CPI
AD
AS
AD1
Y1 – Y* = inflationary gap
Y* - Y2 = recessionary ga
AD2
Y2
Y* Y
1
Real GDP
Potential GDP and AS – long run



Potential GDP (Y*) – the level of output,
which could be achieved given the physical
and institutional constraints of the economic
activity (full employment GDP)
Full employment – the employment level,
determined by the potential output
Natural rate of unemployment (U*) – the
rate of unemployment at the potential GDP
level.
Potential GDP and AS – long run
CPI
LRAS
Long run – the increase in the overall price
level and in the prices of production
Factors are entirely synchronized.
In the long run, the increase in the prices of
final goods and services does not motivate
the firms to increase output, since their cost
would increase at the same rate.
Y*
Real GDP
Potential GDP and AS – long run
Factors, determining AS in the long run:




Labor resources – quantity and quality,
productivity, education, traditions, motivation,
demographic factors
Capital resources – quantity and quality, rate
of capital accumulation
Technological changes
Institutional changes
Macroeconomic equilibrium in
the long run
CPI
AD
AS
Real GDP