Macroeconomics: aggregate supply in the short run

Aggregate supply -short run analysis- :

The aggregate supply is the total amount of goods and services the firms in a country produce at each price level in a fixed period of time.

Sticky-wage and price model:

In the short run, wages and other costs of production are relatively fixed. In other words, workers will not accept to receive a lower wage, when firms want to reduce their costs. Thus, firms must reduce output and layoff workers when aggregate demand drops. However, firms can also benefit from these fixed costs, if the aggregate demand increases (i.e shifts to the right). Prices increases but the costs stay the same, firms earn a bigger profit in the short run.

Short run aggregate supply curve (SRAS):

The SRAS curve is upward sloping, but is relatively flat below the full-employment level of output because of the "stickiness" of wages.

The SRAS curve is relatively steep beyond the full employment level of output, since the firms are physically constraint to what can be produced.

Assume that the point at which the AD curve crosses the SRAS curve is the full employment level of output in the graph above.

Say the nation's AD falls (drop in C,I,G,or Xn), the AD curve would shift to the left, causing both a drop in the price level and in the real national output. Firms have to layoff workers to cut their costs in response to falling demand. Furthermore, a drop in price level causes creates deflation in the economy.

If the nation's AD increases (rise in C,I,G, or Xn) from its full employment output level, this will cause a sharp rise in the price and smaller increase in the output level. This is also known as demand-pull inflation. Where resources have become scarcer and production less efficient. Then, an increase in aggregate demand causes sharp increase in the price level as more demand is (approximately) chasing the same amount of goods.

Reference: Welker, Jason. AP Maroeconomics Crash Course. Research & Education Association (2014). p 123-126.

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