Aggregate Supply II: functions
Possibly redundant unless you are studying AP economics (or equivalent)
Simplified, made-linear, visual, hodge-podge, representations of impacts upon aggregate supply
Such graphical presentations may be useless to you … feel-free to skip ahead
Short-run aggregate supply function
Upward-sloping / positive gradient: firms assumed to increase output, chasing profits as prices rise.
The graph on the left represents falling costs of production. The short-run aggregate supply function ‘shifts right’ (is translated downward by some vector). Price-levels are lower at given level of output A.
-i.e. oil prices fall, lowering costs of production, and the price-level.
The graph on the right represents rising costs of production. The short-run aggregate supply function ‘shifts right’(is translated upward by some vector). Price-levels are higher at given level of output A.
-i.e. oil prices rise, raising costs of production, and the price-level
Long-run aggregate supply function
According to introductory macroeconomics syllabi, opinions on the matter can be reduced to two types:
‘Classical’ on the left, ‘Keynesian’ on the right.
the upright bit - each function includes a portion of gradient infinity (in the left case, the entire function). This wall-like bit represents potential capacity. In the long-run, it is assumed that an economy can not operate beyond its capability.
The ‘classical’ function is entirely vertical: belief that an economy will operate at full capacity in the long-run. The market self-corrects.
-i.e. if wages rise too high, workers may be laid-off; productive capacity temporarily falls; however, high unemployment leads to competition in the job market; workers are desperate for employment and so accept lower wages; at these lower wages, employers can increase hiring; employment rises back toward capacity.
The ‘Keynesian’ function has a horizontal portion (gradient zero): belief that resources can remain unemployed in the long-run. With so much capacity to spare, the inflationary effects of employing these resources will be negligible (hence no price increase with movement along this section).
‘Shifts’ - aka translations:
An increase in economic capacity/efficiency might be represented by a ‘shift’: from LRAS1 to LRAS2 (on either graph). Potential output has increased from A to B at a given price, P.
-i.e. war requires new munitions factory built, increasing productive possibility.
A decrease in economic capacity/efficiency might be represented by a ‘shift’ from: LRAS1 to LRAS3 (on either graph). Potential output has fallen from A to C at a given price, P.
-i.e. bombing raid during war destroys existing munitions factory, reducing productive possibility.