Long Run vs. Short Run
- Long Run
- The period of time where input prices are completely flexible and adjust to changes in the price level (PL)
- In the long run, the Level of Real GDP (GDPR) supplied is independent of PL
- Short Run
- Period of time where input prices are sticky and do not adjust to changes in the PL
- In the short run, the GDPR supplied is directly related to the price level
Long Run Aggregate Supply (LRAS)
- The LRAS marks the level of Full Employment in the economy (can be compared to like the PPC)
- Because input prices are completely flexible in the long run, changes in PL do not change firms' real profits, and thereby do not change firms' level of output.
- This means that the LRAS is vertical at the economy level of Full Employment.
Changes in Short Run Aggregate Supply (SRAS)
- Increase in SRAS= Shift to the Right
- Decrease in SRAS= Shift to the Left
- Key to understanding shifts in SRAS is Per Unit Cost of Production
- Per Unit Cost of Production= Total Input Cost/ Total Output
Determinants of SRAS
- Input Prices
- Productivity
- Legal-Institutional Enviroment
Input Prices
- Domestic Resource Prices
- Wages (75% of all business costs)
- Cost of Capital
- Raw Materials (Commodity Prices)
- Foreign Resource Prices
- Market Power
Increase in Resource Prices= SRAS Shift to the Left
Decrease in Resource Prices= SRAS Shifts to the Right
Productivity
- Productivity= Total Output/ Total Inputs
- More Productivity= Lower Unit Production Cost= Shifts SRAS to the Right
- Lower Productivity= Higher Unit Production Cost= Shifts SRAS to the Left
Legal Institutional Environment
- Taxes and Subsidies
- Taxes ($ to Government) on business increase Per Unit Cost of Production= SRAS to the Left
- Subsidies ($ from Government) to business reduce Per Unit Cost of Production= SRAS to the Right
- Government Regulation
- Government Regulation creates a Cost of Compliance= SRAS Shifts to the Left
- Deregulation reduces Compliance Costs= SRAS to the Right
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