11.2 Short-run and Long-run Aggregate Supply

Aggregate supply is a key concept in macroeconomics, showing how much output an economy can produce at different price levels. It's split into short-run and long-run versions, each with unique characteristics and factors influencing them.

Understanding aggregate supply helps explain economic fluctuations and growth. Short-run supply is affected by input costs and expectations, while long-run supply depends on factors like technology and capital. This knowledge is crucial for analyzing economic policies and predicting outcomes.

Short-Run vs Long-Run Aggregate Supply

Time Frames and Characteristics

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• Short-run aggregate supply (SRAS) represents total output firms produce at different price levels with some fixed input prices
• Long-run aggregate supply (LRAS) represents potential output when all prices, including wages, are fully flexible
• Short run typically spans 1-2 years, long run generally 5-10 years or more
• SRAS curve slopes upward, firms produce more at higher prices in short run
• LRAS curve is vertical, output determined by factors of production and technology, not price level

Key Distinctions

• SRAS vs LRAS differ in flexibility of input prices, particularly wages
• Economy's ability to fully adjust to shocks distinguishes short run from long run
• SRAS affected by temporary factors (input costs, expectations), LRAS by long-term factors (technology, capital stock)
• SRAS allows for price level changes to affect output, LRAS assumes full price adjustment

Factors Influencing Short-Run Aggregate Supply

Input Costs and Productivity

• Input prices (wages, raw materials, energy costs) significantly affect SRAS
• Productivity changes (technological advancements, improved management techniques) shift SRAS curve
• Labor market conditions (unemployment rates, labor force participation) influence labor input availability and cost
• Degree of spare capacity in economy affects firms' ability to increase production

External Factors and Expectations

• Government policies (taxes, subsidies, regulations) impact production costs and supply willingness
• Expectations about future economic conditions and inflation influence current production decisions
• Supply shocks (natural disasters, geopolitical events) cause sudden SRAS curve shifts
• Firms' inventory levels and production capacity utilization affect short-term supply responsiveness

Long-Run Aggregate Supply and Potential GDP

Characteristics of LRAS

• LRAS curve represents economy's potential output (potential GDP or full-employment output)
• Potential GDP sustainable long-term output without generating inflation
• Vertical LRAS curve implies price level changes don't affect long-run productive capacity
• LRAS position determined by quantity and quality of factors of production (land, labor, capital) and technology level

Economic Growth and Natural Rate of Unemployment

• Economic growth shown by rightward LRAS curve shift
• Growth occurs through increases in quantity or quality of production factors or technological progress
• Natural rate of unemployment closely related to LRAS, represents unemployment rate consistent with potential GDP
• Changes in labor force demographics or structural economic shifts can affect natural rate of unemployment

Input Prices and Productivity on Aggregate Supply

Impact of Input Price Changes

• Increased input prices (wages, raw materials) shift SRAS curve leftward, reducing aggregate supply at each price level
• Decreased input prices shift SRAS curve rightward, increasing aggregate supply at each price level
• Magnitude of SRAS curve shift depends on input's relative importance in production process
• Input price changes primarily affect short-run aggregate supply, with limited long-term impact

Productivity and Long-Term Effects

• Productivity improvements (technological advancements, enhanced processes) shift both SRAS and LRAS curves rightward
• Productivity changes have more significant long-term impact on aggregate supply than short-term input price fluctuations
• Supply-side policies reducing input costs or improving productivity can stimulate aggregate supply in short and long run
• Speed of input price or productivity changes affecting aggregate supply varies, causing potential economic adjustment lags