Macroeconomics

‭Imagine‬‭a‬‭scenario‬‭in‬‭which‬‭all‬‭prices,‬‭including‬‭wages‬‭(the‬‭price‬ ‭of‬ ‭labor),‬ ‭simultaneously‬ ‭tripled.‬ ‭What‬ ‭do‬ ‭you‬ ‭expect‬ ‭to‬ ‭see‬ ‭happen‬‭at‬‭the‬‭level‬‭of‬‭output‬‭produced‬‭by‬‭this‬‭economy’s‬‭frms?‬ ‭Probably‬ ‭nothing.‬ ‭When‬ ‭all‬ ‭prices‬ ‭triple,‬ ‭all‬‭costs‬‭triple‬‭as‬‭well.‬ ‭Therefore,‬‭frms‬‭are‬‭in‬‭the‬‭exact‬‭same‬‭position‬‭that‬‭they‬‭were‬‭in‬ ‭before‬‭the‬‭tripling.‬‭If‬‭prices‬‭and‬‭wages‬‭are‬‭both‬‭increasing,‬‭frms‬ ‭get‬ ‭more‬ ‭for‬ ‭their‬ ‭products‬ ‭and‬ ‭pay‬ ‭proportionately‬ ‭more‬ ‭for‬ ‭their workers. This describes supply in the long run.‬

‭Now‬ ‭imagine‬ ‭that‬ ‭wages‬ ‭and‬ ‭prices‬ ‭do‬ ‭not‬ ‭move‬ ‭at‬ ‭the‬ ‭same‬ ‭time.‬‭What‬‭do‬‭you‬‭expect‬‭frms‬‭to‬‭do‬‭in‬‭this‬‭case?‬‭If‬‭wages‬‭are‬‭slower‬‭to‬‭respond‬‭to‬‭a‬‭change‬‭in‬‭demand‬ ‭than‬ ‭product‬ ‭prices,‬ ‭frms‬ ‭will‬ ‭increase‬ ‭their‬ ‭output‬ ‭since‬ ‭product‬ ‭prices‬ ‭are‬ ‭rising‬ ‭leading‬ ‭to‬ ‭higher‬ ‭profts‬ ‭from‬ ‭increases‬ ‭in‬ ‭output.‬ ‭This‬ ‭scenario‬ ‭represents‬ ‭supply‬ ‭in‬ ‭the‬ ‭short‬ ‭run‬ ‭in‬ ‭which‬ ‭many‬ ‭economists believe that wages respond more slowly than prices.‬

‭Short-Run and Long-Run Analyses‬ ‭Short-Run Aggregate Supply (SRAS)‬

‭The‬ ‭short-run‬ ‭aggregate‬ ‭supply‬ ‭(SRAS)‬ ‭represents‬ ‭the‬ ‭output‬ ‭supplied‬ ‭in‬ ‭a‬ ‭period‬ ‭of‬ ‭time‬ ‭when‬ ‭the‬ ‭prices‬‭of‬ ‭factors‬‭of‬‭production‬‭have‬‭not‬‭had‬‭the‬‭time‬‭to‬‭adjust‬‭to‬‭changes‬ ‭in‬‭the‬‭economy,‬‭particularly‬ ‭in aggregate demand and the price level.‬ ‭As‬‭the‬‭price‬‭level‬‭rises‬ ‭,‬‭producers‬‭are‬‭willing‬‭and‬‭able‬‭to‬ ‭supply‬‭more‬ ‭goods‬‭and‬‭services.‬‭Therefore,‬ ‭there‬ ‭is‬ ‭a‬ ‭positive‬ ‭relationship‬ ‭between‬ ‭the‬ ‭price‬ ‭level‬ ‭and‬ ‭AS‬ ‭resulting‬ ‭in‬ ‭an‬ ‭upward-sloping‬ ‭short-run‬‭aggregate‬‭supply‬‭curve‬‭(SRAS‬‭curve).‬‭Similar‬‭to‬‭the‬‭AD‬‭curve,‬‭the‬ ‭SRAS‬‭curve‬ ‭plots‬‭real‬‭GDP‬ ‭on‬ ‭the‬ ‭x-axis‬ ‭and‬ ‭the‬ ‭price‬ ‭level‬ ‭on‬ ‭the‬ ‭y-axis.‬ ‭There‬ ‭are‬ ‭three‬ ‭main‬ ‭reasons‬ ‭for‬ ‭its‬ ‭upward-sloping‬ ‭shape:‬ ‭1.‬ ‭The‬ ‭Proft‬ ‭Effect:‬ ‭As‬ ‭the‬ ‭price‬ ‭of‬ ‭goods‬ ‭and‬ ‭services‬ ‭increases‬ ‭(the‬ ‭general‬ ‭price‬ ‭level),‬ ‭the‬ ‭prices‬‭of‬‭factors‬‭of‬‭production,‬‭such‬‭as‬‭wages,‬‭do‬‭not‬‭change‬‭since‬‭they‬‭are‬‭sticky‬‭in‬‭the‬‭short‬ ‭run.‬ ‭Therefore,‬ ‭the‬‭gap‬‭between‬‭output‬‭and‬‭input‬‭prices‬‭widens,‬‭increasing‬‭the‬‭proft‬‭made‬‭by‬ ‭frms (revenue made from sales > costs paid for resources).‬ ‭2.‬ ‭The‬ ‭Cost‬ ‭Effect:‬ ‭We‬ ‭assumed‬ ‭that‬ ‭input‬ ‭prices‬ ‭and‬ ‭costs‬‭remain‬‭unchanged‬‭in‬‭the‬‭short‬‭run.‬ ‭However,‬ ‭average‬ ‭costs‬ ‭(the‬ ‭cost‬ ‭per‬ ‭unit‬ ‭of‬ ‭output)‬ ‭can‬ ‭increase‬ ‭as‬ ‭output‬ ‭rises.‬ ‭This‬ ‭is‬ ‭because,‬‭for‬‭example,‬‭overtime‬‭work‬‭must‬‭still‬‭be‬‭paid‬‭and‬‭costs‬‭of‬‭recruiting‬‭new‬‭workers‬‭will‬ ‭still‬ ‭be‬ ‭incurred.‬ ‭To‬ ‭cover‬ ‭additional‬ ‭costs‬ ‭involved‬ ‭in‬ ‭producing‬ ‭higher‬ ‭output,‬ ‭suppliers‬ ‭will‬ ‭need to increase their prices.‬ ‭3.‬ ‭The‬ ‭Misinterpretation‬‭Effect:‬ ‭When‬‭the‬‭price‬‭level‬‭increases,‬‭producers‬‭may‬‭misinterpret‬‭this‬ ‭as‬ ‭an‬ ‭increase‬ ‭in‬ ‭the‬ ‭popularity‬ ‭of‬ ‭their‬ ‭own‬ ‭product.‬ ‭As‬ ‭a‬ ‭result,‬ ‭they‬ ‭are‬ ‭encouraged‬ ‭to‬ ‭produce more.‬

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