Aggregate Supply (AS) curve below shows level of real domestic output (real GDP in billions) available at each possible price level, ceteris paribus.
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The upward slope of the curve indicates that producers are willing and able to sell more units of their goods as prices increase, and that their willingness to sell decreases as prices falls. The reasons listed below explaining the AS"s upward sloping shape in the short run:
1. Rigid Wages: Economists believe that wages tend to be fixed by contracts or other agreements. When prices rise, but higher wages do not accompany them , producers" profits will rise temporarily, and the firm will produce more.
2. Sticky Prices: Prices are costly to change in some industries (menu costs). Where this is true, decreases in the general price level will negatively affect sales, profits, and output, causing producers to produce less.
These two reasons given for the upward sloping AS are likely to be true only for short periods of time, and thus the AS curve described above is often called short run AS (SRAS) curve.
A change in the general price level will change the quantity supplied of the domestic output, this is a change along the AS curve. Other economic variables will change the SRAS curve and shift the curve to a new position. Some of these factors are listed below:
1. The Wage Rate: Higher wage rates means higher labor cost. Given constant prices, higher production costs reduce the profit per unit and lowering the number of goods produced. Therefore, higher wage rate shifts the SRAS curve to the left.
2. Prices of Non-labor inputs: Energy, land, capital and other non-labor inputs also have a significant impact on SRAS. An increase in the price of these inputs shifts the SRAS curve to the left.
3. Productivity: This is the output produced per unit of input used over a period of time. Higher productivity of labor or any other inputs will shift the SRAS to the right.
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4. Supply Shock: Major natural or institutional changes will affect AS. Shocks like the Iraq War and 9/11 both impacted the AS.
As mentioned earlier, factors created the upward sloping SRAS are not present in the long run. In the long run, the economy will always produce the full employment real GDP called potential GDP (GDPp) or natural real GDP ( Qn). The long run AS (LRAS) curve will be vertical at this real GDP level. Change in potential GDP will shift the LRAS curve to the right.