We will now discuss each of the three ranges of the AS. In the Keynesian range of AS, we are at outputs which are substantially below Qf. This horizontal range implies an economy in severe recession or depression. Remember that Keynes wrote his General Theory during the heights of the Great Depression, so the range of AS that is associated with his name corresponds to such an economy.
Assume that you were running a factory during a severe recession with high unemployment, and you decided that you would like to increase output. You realize that, to increase output, you are going to have to employ more inputs, primarily more labor—however, a similar argument could be made about high unemployment of any of the other factors of production.
You go to the factory door, open it, and find thousands of unemployed workers standing in line, wanting to work at your factory. How much would you have to pay them to get them to go to work for you? Certainly, you would not have to pay them more than the going wage rate in the market, right? Essentially, you could hire as many unemployed resources as you would like without bidding up wages and prices, because of the substantial unemployment.
The horizontal or Keynesian AS illustrates the idea of the economy being able to increase real output with no increase in the price level during periods of high unemployment. In the Classical Range of AS, we are at or very near the full-employment level of output.
This range is named after the Classical Economists who assumed that the economy, in the long run, would always achieve full employment. Assume again that you are running a factory, only this time, the economy is at full-employment.
You go to the factory door and open it to find nobody waiting in line. There does not appear to be anyone looking for a job because everyone already has one! How much are you going to have to pay these workers to get them to do that? Most likely you will have to pay them more than they are currently making.
As you bid up wages in the labor market to attract additional workers, prices in the economy will also rise, because now it costs more to produce your product. That additional cost is passed to the consumer in the form of higher prices, to the extent possible. Attempts to increase output in the Classical Range leads to higher price levels in the economy but what about real GDP?
Does it actually increase? Well, your output may go up, but the output of the factory where your new workers used to work will go down, so the overall output in the economy stays the same at Qf. In the Intermediate Range, we are at output levels that are below full employment, but not so far below as to constitute a deep recession or depression. In this range, increasing output is possible, but only at the expense of rising prices. While that Keynesian Range is a rare short-run occurrence, and the Classical Range is the long-run steady state of the economy, the Intermediate Range is probably where we find ourselves most often in the economy.
Depending on the state of the economy, any attempt to change the output of the economy will move us along a given AS curve. There are factors that influence aggregate supply, illustratable by shifting the AS curve—these factors are referred to as determinants of AS.
When these other factors change, they cause a shift in the entire AS curve and are sometimes called aggregate supply shifters. The graph below illustrates what a change in a determinant of aggregate supply will do to the position of the aggregate supply curve. As we consider each of the determinants remember that those factors that cause an increase in AS will shift the curve outward and to the right and those factors that cause a decrease in AS will shift the curve upward and to the left.
Anything that causes input prices to rise will decrease AS and shift the AS curve to the left. Anything that causes input prices to fall will increase AS and shift the AS curve to the right.
For instance, if a particular input into the production process is readily available from domestic suppliers, it will generally be cheaper, holding all else constant cet.
If for no other reason, transportation costs of delivering a domestic resource to a domestic producer will be less than delivering the identical resource from a foreign supplier.
That does not even take into account the problems of getting a foreign resource such as duties and tariffs, political or social instability abroad, or other international disruptions.
Another factor that can influence input prices would be the market power of the suppliers of the resource. The more competition in the supply of a resource, the cheaper that resource will be, cet.
If the resource is supplied by a monopolist or a cartel think OPEC oil , the price of that resource will be higher than if the resource is supplied by a more competitive industry think corn-produced ethanol. Independent of its price, anything that makes resources more productive will increase AS and shift the AS curve to the right; anything that makes resources less productive will decrease AS and shift the AS curve to the left.
If workers become more productive because of investments in physical or human capital, the economy will be able to produce more and the AS curve will shift to the right.
If workers become less productive because of outmoded equipment, insufficient training, or excessive union interference in their workplace, the economy will be less productive, and the AS curve will shift to the left.
In brief, business taxes increase the cost of production and shift the AS curve to the left; subsidies decrease the cost of production and shift the AS curve to the right. Government regulations also influence the costs of production. What does the equilibrium between AD and AS determine? Equilibrium is illustrated below as the intersection between AD and AS. Notice that in the intermediate range, there is a tradeoff between two of the key economic variables that concern US citizens: Typically, we would like both inflation and unemployment to be low.
In the intermediate range, however, if we increase AD, inflation will go up as unemployment falls notice that if real GDP is going up, unemployment is going down: On the other hand, if we decrease AD, inflation will fall but unemployment will rise. There is no way to simultaneously decrease inflation and decrease unemployment using demand side shifts.
Do you think that decreases in AD have exactly the opposite effects as the increases? Why do you think that prices would go up very easily but fall only slowly? Part of the answer has to do with the fact that it actually costs businesses money to change their prices think of printing new catalogs, printing new menus, recoding prices in a computer and on scanners, or sending a worker out to change the prices on a marquee.
It is worth it to the business to incur this expense when the price is going up, but when the price is going down they are hesitant to take on the expense of changing prices!
During the s, a variety of factors shifted the AS curve to the left. The high inflation that was combined with a stagnant economy low levels of output and high unemployment gave rise to the term Stagflation. When Ronald Reagan was elected President in , the inflation rate was Reagan employed supply side policies that were designed to shift the AS curve to the right and reduce both inflation and unemployment simultaneously.
Only by supply side policies can you decrease both inflation and unemployment at the same time. By the time that Reagan left office eight years later, the inflation rate in the economy was 4. When the AD curve intersects the AS curve in the Keynesian Range or in the Intermediate Range such that output is below Qf, there exists what is called a recessionary gap.
The gap represents the amount of government spending that would be necessary to shift the AD to the right enough to bring output to Qf. In the Keynesian Model, the magnitude of the shift in AD will depend on the size of the multiplier. For example, if the multiplier is 2. So if the AD needs to be shifted to the right by million dollars to get to Qf and the multiplier is 2. Conversely, if the AD needs to be shifted to the left to get to Qf, there is an inflationary gap and the same multiplier principles would apply.
The changes in government spending that would close an inflationary or recessionary gap are applications of fiscal policy, which is the topic of our next lesson. Course Introduction Section Introduction to Macroeconomics Introduction to Macroeconomics Section Lesson 04 Section Economic Growth in the U. Lesson 07 Section Aggregate Supply Aggregate Supply Section Equilibrium Equilibrium Section Government Spending or Taxes?
Lesson 10 Section Why are there so many interest rates? Lesson 11 Section Summary Summary Lesson 12 Section Trade Importing and Exporting Services Section Conclusion Conclusion Course Conclusion Section The tendency for increases in the price level to lower the real value or purchasing power of financial assets with fixed money value and, as a result, to reduce total spending and real output, and conversely for decreases in the price level.
The tendency for increases in the price level to increase the demand for money, raise interest rates, and, as a result, reduce total spending and real output in the economy and the reverse for price-level decreases.
The inverse relationship between the net exports of an economy and its price level relative to foreign price levels. Factors such as consumption spending, investment, government spending, and net exports that, if they change, shift the aggregate demand curve.
A schedule or curve showing the total quantity of goods and services supplied produced at different price levels. An aggregate supply curve for which real output, but not the price level, changes when the aggregate demand curves shifts; a horizontal aggregate supply curve that implies an inflexible price level. An aggregate supply curve relevant to a time period in which input prices particularly nominal wages do not change in response to changes in the price level.
The aggregate supply curve associated with a time period in which input prices especially nominal wages are fully responsive to changes in the price level. Factors such as input prices, productivity, and the legal-institutional environment that, if they change, shift the aggregate supply curve.
A measure of average output or real output per unit of input. For example, the productivity of labor is determined by dividing real output by hours of work. The gross domestic product at which the total quantity of final goods and services purchased aggregate expenditures is equal to the total quantity of final goods and services produced the real domestic output ; the real domestic output at which the aggregate demand curve intersects the aggregate supply curve.
The reluctance of firms to cut prices during recessions that they think will be short lived because of the costs of altering and communicating their price reductions; named after the cost associated with printing new menus at restaurants. A wage that minimizes wage costs per unit of output by encouraging greater effort or reducing turnover.
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Factors that cause the short-run aggregate supply curve to shift to the left or the right. Decrease in Short-Run Aggregate Supply Producers reduce the quantity of aggregate output they are willing to supply at any given aggregate price level.
Start studying Aggregate Demand & Aggregate Supply. Learn vocabulary, terms, and more with flashcards, games, and other study tools. A shift to the left means a decrease in aggregate supply, a shift to the right means an increase in aggregate supply What does an increase in aggregate supply mean? An increase indicates that firms are willing to produce and .
The price level at which the aggregate demand curve intersects the aggregate supply curve. Equilibrium Real Output The GDP at which the total quantity of final goods and services purchased is equal to the total quantity of final goods and services produced; the real domestic output at which the aggregate demand curve intersects the aggregate . Start studying Determinants of Aggregate Demand and Supply. Learn vocabulary, terms, and more with flashcards, games, and other study tools.