Economics Online Tutor
Aggregate Supply Curve
The aggregate supply (AS) curve is a graph of the level of real GDP that
firms will be willing to produce at various price levels. The aggregate
supply curve is different in the short run than in the long run.
Firms are willing to supply more output whenever profitability increases. An
increase in the prices of output, holding all other factors constant, will
increase profitability and the level of real output. This means that a positive
relationship exists between the price level and the real GDP supplied. The
AS curve slopes upward.
The aggregate supply curve becomes steeper as the price level rises. This
is because at higher levels of output, more firms reach capacity and cannot
respond to higher prices with an increase in output, at least in the short run.
The upward slope of the AS curve generally holds true in the short run.
Holding all other factors constant is at least partially realistic in the short
run. Profits increase with a higher price level in the short run because input
prices tend to be more inflexible than output prices. For example, wage
rates may be set by contract and are based on historical or expected price
levels, not actual price levels. A time lag may also exist before suppliers
raise their prices.
In the long run, however, input prices have time to adjust to changes in the price level. Real profits
will not necessarily increase with a higher price level. With no increase in long run profits, the
aggregate supply curve loses its upward slope. As a result, in the long run real GDP will not change
with a price level change. The long run aggregate supply curve becomes a vertical line.
Many economists agree that this vertical line is at the level of real GDP that coincides with the
natural rate of unemployment. This means that long run real GDP would be equal to potential GDP.
This vertical long run aggregate supply curve, at the natural rate of unemployment level of output,
does not mean that long run real GDP is fixed. Both the long run and the short run aggregate supply
curves shift as changes occur in the non-price determinants of aggregate supply. Technological
advances and increases in resources allow for economic growth in the long run.
Non-price determinants of aggregate supply
The non-price determinants of aggregate supply are resource prices, technology, and expectations.
Resource prices: as stated above, resource prices do not fully adjust to changes in the overall price
level in the short run. When resource prices do change, profitability and the level of aggregate
supply also change. An increase in resource prices will shift the AS curve to the left. Only changes
in the prices of resources, and not changes in the overall price level, will create this shift in the
aggregate supply curve.
Technology: technological advances increase efficiency. New technology allows more output to be
produced with the same level of resource inputs. This lowers the costs of production. As a result,
firms are willing to supply more output, and the AS curve shifts to the right.
Expectations: expectations of the future price level will cause shifts in the current aggregate supply
curve. When wage contracts are renewed, an expected increase in the price level can cause an
increase in current input prices, reducing aggregate supply. Expectations of higher prices shift the
AS curve to the left. Since a leftward shift in the aggregate supply curve creates a higher price
level, this means that anticipated higher prices can cause higher prices. In effect, the expectation of
inflation becomes a self-fulfilling prophesy.
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