Aggregate Demand and Aggregate Supply Analysis
Short Run Aggregate Supply
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Alright. So we've seen aggregate supply in the long run now let's check it out in the short run. So we're still in this A. D. A. S. Model, right, aggregate demand and aggregate supply. Well when we talk about aggregate supply, right, we had the long run aggregate supply that was that straight up and down uh curve. But the short run aggregate supply is gonna look a little more familiar to what we studied with our market supplies. So in the short run, well the quantity of Real GDP is affected by current price levels. Remember in the long run we said that it had to do with the factors of production, how much how much labor we had in our economy, how much capital, how much we had available to produce stuff. And in the long run, well that was gonna be capped out at that amount. But in the short run well the prices are going to affect how much is going to be produced. So Real GDP remember goods and services produced when we say real, we're not really thinking about the prices there, but the amount that's being produced. So in the short run the price is going to affect the amount being produced. All right. So in the short run an increase in the price level will lead to uh an increase in production of goods and vice versa, right? A decrease in the price level will lead to a decrease of the production of goods. Alright, so here we're gonna draw our short run aggregate supply and if you remember from our market supply and demand at the beginning of the course, what did our supply curve look like? It just went like this, right? It started down here and as the price went up, we supplied more, Right, higher prices, more supply. Well, the same thing's gonna happen here in the short run the price level. Remember when we're talking about aggregate supply? Well, we're now including all goods and services in the economy. So the price level of goods and services is gonna be our access there. And G. D. P. We're talking about real GDP here, so, a quantity of goods and services being provided in the economy. So here we go, we've got our short run aggregate supply. So it looks very similar to what we had in in market demand and supply. Right, So let's go ahead and pause here. And in the next video, let's discuss why the aggregate supply. Remember now we have to think about macroeconomic conditions that lead us to having this type of curve in the short run. Okay, So what does it tell us? Well, remember a low price level, that means in the short run we're gonna have a lower GDP at some low price level, we'll say lo here, compared to up here, right, if there's some higher price level, we're gonna have some higher GDP GDP high GDP, low price, high price level, high. Right? So something like what we're used to in market supply and demand. Alright, so let's pause real quick and let's talk why this is the case.
SRAS Slopes Upwards
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So there's three theories that come into play when we think about why the short run aggregate supply curve tends to have this upward slope, like we see in our graph. Okay, so some of these might be a little contradictory, but the idea is that they all tend to show why the short run would go up as the price level goes up. So let's think about the first one here, the sticky wage theory. So sticky. Remember when we talked about sticky verse, flexible, sticky means more or less fixed, right? That the wages are going to be more fixed. So sticky wage theory says that wages do not increase as quickly as the price level. So what we're going to see is the prices going up during an economic boom, but the wages don't increase as quickly, right? You don't see that your boss, you work at a coffee shop or something and the prices are going up and they're like, hey, we're charging more here, take more money as well. Usually the wages don't go up as fast as the price level goes up. So what does that do for profit if we see this selling price going up, But this wage, right? The cost of running the restaurant or running your business stays equal? Well, the selling price is going up, the cost is staying the same, so there's gonna be more profit, right? The profit is gonna be going up as well. So what does that tell us that they're gonna want to supply more, right? As those price levels go up, they're gonna want to supply more because their costs are staying relatively stable while their prices are going up? So they're gonna want to supply more. Another example of why these wages are sticky is union wages unions usually set their wages in a contract and it's gonna be fixed over several years, so if the economy starts to boom, well those, those wages are fixed and they're not gonna boom as well. Alright, so that's the sticky wage theory. How about the sticky price theory? So this one kind of contradicts in the way that now we're saying that some prices do not increase in line with, with the price level. So now we're saying that some of the prices aren't going up as quickly. So the sticky wage theory is saying that wages don't go up as quickly. The sticky price theory is saying some prices don't seem to go up as quickly, and that's because of this idea of menu costs. We might have talked about this before, but the idea of menu cost is a cost businesses face from changing prices. And the illusion here is to a restaurant having to print a new menu and the cost of printing a new menu when they're changing their prices. If they want to have higher prices, they're gonna have to change the menu, reprint everything right, So that's going to cost them money. So maybe some restaurants would say, hey, I'd rather just keep the same menu, So I don't have to put in all that money to change uh to change what are many looks like. So how does this sticky price theory relate to this short run aggregate supply, having that upward curve? Well, if those price levels do not go up. So um in this example of the restaurant that doesn't increase its prices, well that restaurants gonna have lower prices compared to other places, right? And it's going to increase their sales quantity, which leads to higher output, Right? So at those higher price levels in the economy, these places that didn't raise their prices, even though the economy wide prices have gone up, Well, they're going to see more business and they're gonna have to produce more to keep up with that higher level of business, right? When they when people go to their cheaper restaurant, Right? So the sticky wage theory, sticky price theory, they both show us how uh as the price level goes up, the quantity goes up, right, the quantity that's gonna be supplied. And finally, we have the misperceptions theory. I say, the two most important are these two, they they seem to come up the most. But misperception theory just, it's kind of that when when businesses see general price levels increase, they respond with increased output, they say, hey, the prices are going up. That's good for us, let's let's produce more, right? So that's kind of a misperception that they just see higher prices and they just decided to produce more. Okay, so sticky wage theory, wages are staying fixed, sticky price theory, some prices are staying fixed, leading to more business coming in because of the lower perceived prices that they have and misperception theory, people just say, hey, higher prices, let's produce more. Cool, Alright, let's pause here and move on to the next.