Foundations Of Aggregate Supply
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Foundations of aggregate supply
Recall: • Aggregate supply -Describes the behavior of the production side of the economy -Total quantity of goods and services that businesses willingly produced and sell in a given period. Aggregate supply Curve/ AS Curve -schedule showing the level of total national output that will be produced at each price level
Recall: • Short-run AS schedule -not more than a decade -upward sloping -higher prices are associated with increase in the production of goods and services Long-run AS Schedule -period of several years or a decade more -vertical AS schedule -increase in the price level are not associated with an increase in total output supplied
Determinants of Aggregate supply • Potential Output (Potential GDP) -maximum sustainable output that can be produce without triggering rising inflation -highest sustainable level of national output -the output that would be produced at a target level of the unemployment rate called nonaccelerating inflation rate of unemployment. Input(land, labor, capital) Technology and Efficiency
Determinants of Aggregate supply Potential Output IS NOT Maximum Output
Maximum sustainable output but not the absolute maximum output that an economy can produce
Analogy: Someone Running a Marathon “Think of potential output as the maximum speed that a marathoner can run without being overheated and dropping out of exhaustion.”
a. Increase in potential output Potential output
Price level
AS
AS’
Q QP Real output
QP’
Determinants of Aggregate supply • Input Costs Wages -lower wages lead to lower production costs -lower costs means that quantity supplied will be higher at every price level for a given potential output Import Prices -decline in foreign prices or an appreciation in the exchange rate reduces import prices. This leads to lower production costs and raises aggregate supply.
Determinants of Aggregate supply Other Input Costs Lower oil prices or less burdensome environmental regulations lowers production costs and thereby raises aggregate supply
b. Increase in costs AS’’
Potential output
Price level
AS
Real Output
QP
Q
Aggregate supply and potential output P
Price level (1996=100)
2
AS curve for 2000
1 AS curve for 1982
Q 2,ooo
4,ooo
6,ooo
8,ooo
Real GDP(billions, 1996 prices)
Aggregate Supply in the Short Run and Long Run
Views in looking at Aggregate Supply • Keynesian – upward-sloping; indicates that firms are willing to increase their output levels in response to changes in aggregate demand, particularly when there is a slack in the economy. • Classical Approach– the level of output supplied is independent of aggregate demand.
During Short-runs… • Some elements of business are inflexible or sticky. • As a result of this inflexibility, business can profit from higher levels of aggregate demand by producing more output.
Potential Output
Price Level P
AS
Q
Qp
Real Output
Example! • Wages – Wages adjust slowly when economic conditions change for a number of reasons. – Workers are less likely to get an increase in their wages more than once a year. – So firms can adjust the production to suit the aggregate demand.
However, during long-runs… • Eventually, the inflexible or sticky elements of costs—wage contracts, rent agreements, regulated prices, and so forth—become unstuck and negotiable. • In the long-run, after all elements of cost have fully adjusted, firms will face the same ratio of price to costs as they did before the change in demand. • The long-run AS curve therefore tends to be vertical, which means that output supplied is independent of the levels of prices and costs
Potential Output
Price Level P
Q
Qp
Real Output
UNEMPLOYMENT
TERMS • Employed – People who perform paid work
• Unemployed – People who currently have no work but are willing and able to work
• Labor Force – All people who are employed and unemployed
TERMS • Unemployment rate – The number of unemployed divided by the total labor force
IMPACT OF UNEMPLOYMENT • Economic Impact “When unemployment goes up, the G&S that the unemployed workers could have produced are in effect as if being thrown away.”
• Social Impact
OKUN’S LAW The most distressing consequence of recession is the rise of a unemployment rate. Okun’s Law states the for every 2 percent that GDP falls relative to the potential GDP, the unemployment rate rises about 1 percentage point. Unemployment usually moves inversely with output over the business cycle. This co-movement was first identified by Arthur Okun.
According to Okun’s Law, whenever output grows 2 percent faster than potential GDP, the unemployment rate declines 1 percentage point. Unemployment changes are well predicted by the rate of GDP growth. One important consequence of Okun’s Law is that actual GDP must grow rapidly as potential GDP just to keep the unemployment rate from rising. In sense, GDP has to keep running just to keep unemployment in the same place. Moreover, if you want to bring the unemployment rate down, actual GDP must be growing faster then potential GDP. Okun’s Law provides the vital link between the output market and the labor market. It describes the association between short-run movements in real GDP and changes in unemployment.
Economic Interpretation of Unemployment Maguad, John Albert T. 2009-21425
• What are the reasons for being unemployed? • What is the distinction between voluntary and involuntary unemployment?
Three Kinds of Unemployment • Frictional Unemployment
• Structural Unemployment • Cyclical Unemployment
Frictional Unemployment • Arises because of the incessant movement of people between regions and jobs or through different stages of the life cycle. • Frictionally unemployed workers are often moving between jobs or looking for better jobs.
Structural Unemployment • Signifies a mismatch between the supply of and the demand for workers. • We often see structural imbalances across occupations or regions as certain sectors grow while others decline.
Cyclical Unemployment • Exists when the overall demand for labor is low. • As total spending and output fall, unemployment rises virtually everywhere.
Voluntary and Involuntary Unemployment
Sources of Wage Inflexibility • Why do wages not move up or down to clear markets?
• Auction Markets • Administered Markets
Labor Market Issues
Duration of unemployment
Sources of joblessness 1982
2000
Job loser
5.7
1.8
Reentrant
2.2
1.3
New entrant
1.1
0.3
Job leaver
0.8
0.5
Unemployment by age Age
White
Black
16-17
15.2
31.1
18-19
11.1
27.6
20-24
6.9
16.2
25-34
4.1
8.1
35-44
3.2
6.4
45-54
2.8
4.8
55-64
2.9
3.9
65-69
2.9
4.8
70-74
2.8
3.1
Over 75
2.8
3.3
Philippines
Youth unemployment 2009
17.4
2008
17.5
2007
14.9
2006
16.9
2005
16.4
2004
21.7
2003
20.1
2002
21.4
2001
19.0
2000
21.2
Recall: • Aggregate supply -Describes the behavior of the production side of the economy -Total quantity of goods and services that businesses willingly produced and sell in a given period. Aggregate supply Curve/ AS Curve -schedule showing the level of total national output that will be produced at each price level
Recall: • Short-run AS schedule -not more than a decade -upward sloping -higher prices are associated with increase in the production of goods and services Long-run AS Schedule -period of several years or a decade more -vertical AS schedule -increase in the price level are not associated with an increase in total output supplied
Determinants of Aggregate supply • Potential Output (Potential GDP) -maximum sustainable output that can be produce without triggering rising inflation -highest sustainable level of national output -the output that would be produced at a target level of the unemployment rate called nonaccelerating inflation rate of unemployment. Input(land, labor, capital) Technology and Efficiency
Determinants of Aggregate supply Potential Output IS NOT Maximum Output
Maximum sustainable output but not the absolute maximum output that an economy can produce
Analogy: Someone Running a Marathon “Think of potential output as the maximum speed that a marathoner can run without being overheated and dropping out of exhaustion.”
a. Increase in potential output Potential output
Price level
AS
AS’
Q QP Real output
QP’
Determinants of Aggregate supply • Input Costs Wages -lower wages lead to lower production costs -lower costs means that quantity supplied will be higher at every price level for a given potential output Import Prices -decline in foreign prices or an appreciation in the exchange rate reduces import prices. This leads to lower production costs and raises aggregate supply.
Determinants of Aggregate supply Other Input Costs Lower oil prices or less burdensome environmental regulations lowers production costs and thereby raises aggregate supply
b. Increase in costs AS’’
Potential output
Price level
AS
Real Output
QP
Q
Aggregate supply and potential output P
Price level (1996=100)
2
AS curve for 2000
1 AS curve for 1982
Q 2,ooo
4,ooo
6,ooo
8,ooo
Real GDP(billions, 1996 prices)
Aggregate Supply in the Short Run and Long Run
Views in looking at Aggregate Supply • Keynesian – upward-sloping; indicates that firms are willing to increase their output levels in response to changes in aggregate demand, particularly when there is a slack in the economy. • Classical Approach– the level of output supplied is independent of aggregate demand.
During Short-runs… • Some elements of business are inflexible or sticky. • As a result of this inflexibility, business can profit from higher levels of aggregate demand by producing more output.
Potential Output
Price Level P
AS
Q
Qp
Real Output
Example! • Wages – Wages adjust slowly when economic conditions change for a number of reasons. – Workers are less likely to get an increase in their wages more than once a year. – So firms can adjust the production to suit the aggregate demand.
However, during long-runs… • Eventually, the inflexible or sticky elements of costs—wage contracts, rent agreements, regulated prices, and so forth—become unstuck and negotiable. • In the long-run, after all elements of cost have fully adjusted, firms will face the same ratio of price to costs as they did before the change in demand. • The long-run AS curve therefore tends to be vertical, which means that output supplied is independent of the levels of prices and costs
Potential Output
Price Level P
Q
Qp
Real Output
UNEMPLOYMENT
TERMS • Employed – People who perform paid work
• Unemployed – People who currently have no work but are willing and able to work
• Labor Force – All people who are employed and unemployed
TERMS • Unemployment rate – The number of unemployed divided by the total labor force
IMPACT OF UNEMPLOYMENT • Economic Impact “When unemployment goes up, the G&S that the unemployed workers could have produced are in effect as if being thrown away.”
• Social Impact
OKUN’S LAW The most distressing consequence of recession is the rise of a unemployment rate. Okun’s Law states the for every 2 percent that GDP falls relative to the potential GDP, the unemployment rate rises about 1 percentage point. Unemployment usually moves inversely with output over the business cycle. This co-movement was first identified by Arthur Okun.
According to Okun’s Law, whenever output grows 2 percent faster than potential GDP, the unemployment rate declines 1 percentage point. Unemployment changes are well predicted by the rate of GDP growth. One important consequence of Okun’s Law is that actual GDP must grow rapidly as potential GDP just to keep the unemployment rate from rising. In sense, GDP has to keep running just to keep unemployment in the same place. Moreover, if you want to bring the unemployment rate down, actual GDP must be growing faster then potential GDP. Okun’s Law provides the vital link between the output market and the labor market. It describes the association between short-run movements in real GDP and changes in unemployment.
Economic Interpretation of Unemployment Maguad, John Albert T. 2009-21425
• What are the reasons for being unemployed? • What is the distinction between voluntary and involuntary unemployment?
Three Kinds of Unemployment • Frictional Unemployment
• Structural Unemployment • Cyclical Unemployment
Frictional Unemployment • Arises because of the incessant movement of people between regions and jobs or through different stages of the life cycle. • Frictionally unemployed workers are often moving between jobs or looking for better jobs.
Structural Unemployment • Signifies a mismatch between the supply of and the demand for workers. • We often see structural imbalances across occupations or regions as certain sectors grow while others decline.
Cyclical Unemployment • Exists when the overall demand for labor is low. • As total spending and output fall, unemployment rises virtually everywhere.
Voluntary and Involuntary Unemployment
Sources of Wage Inflexibility • Why do wages not move up or down to clear markets?
• Auction Markets • Administered Markets
Labor Market Issues
Duration of unemployment
Sources of joblessness 1982
2000
Job loser
5.7
1.8
Reentrant
2.2
1.3
New entrant
1.1
0.3
Job leaver
0.8
0.5
Unemployment by age Age
White
Black
16-17
15.2
31.1
18-19
11.1
27.6
20-24
6.9
16.2
25-34
4.1
8.1
35-44
3.2
6.4
45-54
2.8
4.8
55-64
2.9
3.9
65-69
2.9
4.8
70-74
2.8
3.1
Over 75
2.8
3.3
Philippines
Youth unemployment 2009
17.4
2008
17.5
2007
14.9
2006
16.9
2005
16.4
2004
21.7
2003
20.1
2002
21.4
2001
19.0
2000
21.2
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