Monday, January 12, 2015

Aggregate Supply Short-Run

Aggregate Supply (AS):  is defined as the planned level of output that domestic firms are willing to offer at different average price levels per period of time.

Short-run aggregate supply (SRAS) - the period of time in which money (nominal) wages are assumed fixed over the short-run and unable to adjust to changes in the average price level.

Why, fixed?
1) Contracts cannot be broken.
2) Workers are slow, unaware of price level increases/decreases and therefore are slow to recognize their purchasing power has been affected.

SRAS Curve
Upward sloping as Price Levels (PL)'s rise, firms enjoy larger profits and therefore produce more.

Shifting of the SRAS Curve: Right

Causes of the shift right of the SRAS curve: (decrease in production costs)
  • Decrease in wages (not in the SR)
  • Increase in physical capital stock
  • Increase in technology
  • Increase in subsidies
  • Decrease in business taxes
  • Expectations that the price level will decrease
1) Price Level: decrease
2) GDP: increase
3) Unemployment: decrease

Shifting of the SRAS Curve: Left

Causes of the shift left of the SRAS curve: (increase in production costs)
  • Increase in wages (not in the SR)
  • Decrease in physical capital stock
  • Decrease in technology
  • Decrease in subsidies
  • Increase in business taxes
1) Price Level: increase
2) GDP: decrease
3) Unemployment: increase

2000 AP Macroeconomic Exam
Answer (C) - wages are a cost of production. Lower wages and aggregate supply will shift right.

(A) an increase in interest rates will increase the costs of production, (leftward shift of SRAS)
(B) increasing taxes would increase production costs (shifting SRAS left)
(D) mandates on pollution increases production costs (leftward shift)
(E) shutdown and movement of goods equals higher production costs. (left shift)

2000 AP Macroeconomic Exam

Answer (A) an increase in productive resources will shift the SRAS curve to the left.

(B) Productivity increases lower production costs and therefore would shift the SRAS right.
(C) Increases in the money supply would lower interest rates and shift AD right.
(D) A budget deficit implies that money is being spent, a rightward shift of AD.
(E) Imports increasing means that exports relatively are decreasing, AD shifts left.

2005 AP Macroeconomic Exam

Answer (C) III the cost of all inputs (production costs)

Interactive AD/AS practice

Aggregate Demand & Supply Cheat Sheet

Aggregate Demand & Supply Cheat Sheet 
(Need a bigger copy of the below? E-mail

Tentative,,  AP FRQ Cheat sheet. It is very clear that the bulk of recent past exams have been moving from equilibrium/ recession to recession/recession-LR. Still, knowing that in the short-run, the SRAS curve (usually) does not shift and so a movement during this time usually starts with fiscal policy actions (government spending) that increases AD to push the economy back to equilibrium. Get familiar with the terminology of how the College board asks these questions (triggers), you must understand all of these graphs!!!!

I'll write that again, in the short-run (For the AP) the SRAS (usually) does not shift,, only AD. 
(As some questions are stand alone questions this rule is for questions that usually involve starting the economy in equilibrium or recession,, moving into recession and then the government refraining from action. Over time prices and wages adjust, a shifting of the SRAS) 

In the Long-Run , SRAS shifts moving the economy back to equilibrium. 

Let me see if I can be a bit more clear.

The SRAS curve obviously can shift in the Short-Run as it does when Negative supply shocks occur 2004B & 2006(Stagflation) or when Positive supply shocks occur (Economic Growth) or when the government decides to lower business taxes(2004B) to offset the effects of Stagflation. (think, Keynesianism) 

The difference being that SRAS shifts on its own in the long-run to offset happenings in the economy. If the economy has been experiencing inflation (rising production costs) the firm will (in the long-run) begin to reduce employment and output, while passing higher costs onto consumers as higher prices. The economy will return to equilibrium (with higher PL's),, the point to be taken away is that in the LR the economy will be self correcting with a shifting of the SRAS curve. (think classical/monetarists economists and flexible prices & wages).