Ch 11 - Chapter 11 - Aggregate Supply 1. Aggregate Supply...

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Chapter 11 - Aggregate Supply 1. Aggregate Supply in the Short Run a. Aggregate Supply is the relationship between the price level in the economy and the aggregate output firms are willing and able to supply, with other things constant b. Labor and Aggregate Supply i. Labor is the most important resource, accounting for about 70% of production cost 1. The quantity of labor supplied depends on the wage ii. The higher the price level, the less any given money wage will purchase, so the less attractive that wage is to workers iii. Nominal Wage (Money Wage) is wage measured in current dollars iv. Real Wage is wage measured in dollars of constant purchasing power, or wage without inflation factored in 1. Both workers and employers care more about the real wage than about the nominal wage 2. But because the price level will change over the life of wage agreements, all labor contracts must be negotiated in terms of nominal wages, not real wages a. These agreements are based on the Expected Price Level 3. Wage agreements may be either Explicit (based on a labor contract) or Implicit (based on labor market practices) c. Potential Output and the Natural Rate of Unemployment i. Negotiating wage agreements 1. Firms and resource suppliers expect a certain price level to prevail in the economy during the year, forming a Consensus view for the upcoming year, and wage agreements are formed based on the consensus expectations ii. Potential Output is the economy's maximum sustainable output, given the supply of resources, technology, and production incentives 1. Can be thought of as the economy's "normal capacity," so production can temporarily exceed that capacity 2. It is the output level when there are no surprises about the price level 3. Potential output is also referred to as Natural Rate of Output and the Full-Employment Rate of Output iii. Natural Rate of Unemployment is the unemployment rate that occurs when the economy is producing its potential GDP, and prevails when cyclical unemployment is zero d. Actual Price Level Higher than Expected i. The Short Run is a period during which some resource prices remain fixed by contract ii. A higher price level means the selling price of the firm's goods are higher than expected, on average, while the cost of at least one resource remains constant by a price contract iii. Because a price level that is higher than expected results in a higher profit per unit, firms have an incentive in the short run to increase production beyond the economy's potential level e. Why Costs Rise When Output Exceeds Potential i. As the economy expands and the unemployment rate declines, additional workers are harder to find ii. The nominal cost of labor will increase as output expands in the short run if:
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1. Few additional workers are available 2. Workers require additional pay for overtime 3. Available workers are less qualified - those people who have been structurally unemployed iii. As production increases, the demand for non-labor resources increases too, since
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This note was uploaded on 04/29/2008 for the course ECO 2307 taught by Professor Menkin during the Spring '08 term at Baylor.

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Ch 11 - Chapter 11 - Aggregate Supply 1. Aggregate Supply...

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