Week 10, Day 2 - Chapter 10 Overheads (revised)

Week 10 Day 2- - Chapter 10 – Aggregate Supply and Aggregate Demand Short-Run Aggregate Supply(SRAS Shifts of SRAS Long-Run Aggregate Supply(LRAS

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Unformatted text preview: Chapter 10 – Aggregate Supply and Aggregate Demand Short-Run Aggregate Supply (SRAS) Shifts of SRAS Long-Run Aggregate Supply (LRAS) Shifts of LRAS Aggregate Demand (AD) Shifts of AD The Multiplier AS-AD Model Short-Run Equilibrium Long-Run Equilibrium Macroeconomic Policy Algebraic Model of the Economy In this chapter, we build the aggregate supply - aggregate demand (AS-AD) model of the economy. The model consists of the short-run aggregate supply (SRAS) curve, the long-run aggregate supply (LRAS) curve and the aggregate demand (AD) curve. Short-Run Aggregate Supply (SRAS) The SRAS curve shows the amount of aggregate output (as measured by real GDP) that producers wish to produce in relation to the aggregate price level (as measured by the GDP deflator or the CPI). The SRAS is positively sloped. Increases in the aggregate price level make it more profitable for producers because some of their costs (commodity prices and nominal wages) are fixed in the short-run. As a result of increases in profit per unit of output, firms increase their production and the economy’s aggregate output increases. Commodity prices and nominal wages can be fixed in the short-run because firms have signed contracts such as labour contracts with workers that specify the nominal wage (the dollar amount of the wage paid or the wage unadjusted for inflation). Nominal wages can be fixed even without labour contracts because firms are reluctant to reduce wages for fear of creating worker resentment. Likewise, firms are reluctant to raise wages out of fear of sparking further wage increases. This inflexibility is known as sticky wages. For simplicity, assume nominal wages are fixed along the SRAS curve. An increase in the aggregate price level causes a movement along the SRAS curve to higher levels of aggregate output. Shifts of the SRAS Curve The following cause shifts in the SRAS curve (known as a supply shocks). 1) Changes in commodity prices – An increase in the price of a commodity (such as oil) increases the cost of producing each unit of final output. Ceteris paribus, profit per unit is lower and producers decrease the quantity of aggregate output supplied at every aggregate price level (ie the SRAS curve shifts to the left). 2) Changes in nominal wages – An increase in nominal wages (including other employer paid employee expenses such as health and disability insurance and payroll taxes) increases the cost per unit of producing final output. Ceteris paribus, profit per unit is lower and producers decrease the quantity of aggregate output supplied at every aggregate price level (ie the SRAS curve shifts to the left). 3) Changes in productivity – An increase in productivity decreases the production cost per unit. Ceteris paribus, profit per unit is higher and producers increase the quantity of aggregate output supplied at every aggregate price level (ie the SRAS curve shifts to the right)....
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This note was uploaded on 10/13/2009 for the course ECON 1221 taught by Professor Whitaker during the Winter '09 term at Langara.

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Week 10 Day 2- - Chapter 10 – Aggregate Supply and Aggregate Demand Short-Run Aggregate Supply(SRAS Shifts of SRAS Long-Run Aggregate Supply(LRAS

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