SLOPE, SHORT-RUN AGGREGATE SUPPLY CURVE: The positive slope of the short-run aggregate supply curve, reflecting the direct relation between the price level and real production, results for three primary reasons--inflexible resources, frictional and structural unemployment, and purchasing power imbalances.The short-run aggregate supply (SRAS) curve graphically represents the direct relation between the price level and aggregate real production. A higher price level is related to more real production and a lower price level is related to less real production. That is, the business sector is inclined to offer more total goods and services for sale if the price level rises and less if the price level falls. The key question is: Why? Why does the short-run aggregate supply curve have a positive slope? While the general reason is similar to that of market supply curves--the opportunity cost of production--three specific reasons are at work:
Note that the green vertical line in this graph designates the full employment level of real production.
Opportunity Cost of ProductionWhile the specific mechanism of moving along the short-run aggregate supply curve is more complex, the basic source of the short-run aggregate supply curve's positive is very similar to that for the standard market supply curves--the opportunity cost of production. For market supply, increased production of a good is associated with a greater opportunity cost of production, and thus supply price. Decreased production is related to a lower opportunity cost of production and supply price. The underlying reason for this direct relation between supply price and quantity supplied for market supply can be found in the law of diminishing marginal returns.The positive slope of the short-run aggregate supply curve and the direct relation between price level and aggregate real production is also generally attributable to the opportunity cost of production. That is, an increase in the aggregate real production by the business sector in the short run involves a greater overall opportunity cost of production and thus price level. A decrease in aggregate real production is related to lower opportunity cost and price level. In other words, larger quantities of aggregate real production carry a higher price level because the opportunity cost of production is also greater. Inflexible Resource PricesBy definition, the short run is a period in which some prices, particular resource prices, are inflexible. This inflexibility prevents resource markets from eliminating shortages and surpluses and achieving equilibrium. In other words, workers' wages do not decline even when unemployment rises. Inflexible resource prices, especially wages, are most important when the price level and real production decline. Faced with falling economic activity, resource employment and real production tend to fall first, bearing the brunt of the reduction, while resource prices remain relatively unchanged.Suppose, for example, that The Wacky Willy Company, which manufactures Wacky Willy Stuffed Amigos (those cute and cuddly armadillos and turtles) faces falling demand reflected by a lower price that buyers are willing to pay. With less revenue, The Wacky Willy Company needs to cut production cost. In the short run, it is likely to do so by reducing production and resource employment rather than resource prices.
Natural UnemploymentNatural unemployment consists of frictional and structural unemployment.
However, both frictional and structural unemployment can be reduced temporarily. And when they are reduced, the economy's total employment and aggregate real production increase. This pool of natural employment provides a means of increasing real production beyond full employment when the price level rises. A higher price level, brought about by expanding economic activity, entices firms and resource owners to incur the extra cost needed to reduce natural unemployment and increase real production. Once again, consider the operation of The Wacky Willy Company. When business is booming, like any firm, The Wacky Willy Company is prompted to expand production by increasing the quantities of resources used. In other words, they hire more workers and buy more of the other resources used. While they are not particularly concerned with the economy's full employment level of production, it affects their ability to acquire the resources needed to produce more Stuffed Amigos. In principle, if the economy is at full employment, then the only way for The Wacky Willy Company to acquire more resources is to hire them away from other firms. While this might work for The Wacky Willy Company, ALL firms in the economy CANNOT do this. When The Wacky Willy Company hires workers away from another firm, say Mona Mallard Duct Tape, then Mona Mallard has fewer workers and is forced to reduce production. Mona Mallard might then seek to maintain or even increase its workforce by hiring workers away from OmniMotors, Inc., forcing OmniMotors to reduce production. With full employment, greater production by one firm generally comes at the expense of less production by another. Natural unemployment, however, provides a pool of resources that temporarily allows firms to circumvent the restrictions imposed by full employment. The Wacky Willy Company's pursuit of extra resources might actually draw from the pool of frictional and structural unemployment. For example, The Wacky Willy Company's employee search efforts might involve extensive use of classified ads, which provides the information needed to reduce the search time that exists when frictionally unemployed workers are without jobs. Alternatively, The Wacky Willy Company might provide training for workers who lacked the skills needed for Stuffed Amigos production. Doing so removes some people from the ranks of the structurally unemployed. The result of The Wacky Willy Company's attempts to increase production, along with that of other firms throughout the economy, is that aggregate real production does increase. But this increase comes from drawing upon the ranks of frictional and structural unemployment. The extra cost of searching out frictionally unemployed workers and/or training structurally unemployed workers necessitates a higher price level. Real Resource PricesThe quantities of resources supplied to firms depends on the purchasing power of the resource prices received, that is real resource prices. For labor, the common term is real wages.
Aggregate real production can increase or decrease--can be more or less than full employment production--when real resource prices are out of balance, that is, not the levels needed for full employment. Real resource price imbalances can result either from misperceptions of actual prices or different rates of price adjustments. In particular, if resource owners think real resource prices are higher (or lower) than they actually are, then they are inclined to supply larger (or smaller) resource quantities than that for full employment. Alternatively, real resource prices actually might be higher (or lower), temporarily, than that for full employment because some prices adjust faster than other prices. In either case, the result is that real production is greater (or less) than full-employment production. Consider once again The Wacky Willy Company. Faced with booming sales, it might be inclined to increase workers' wages to entice the greater productive effort needed to keep pace with sales. Workers see these higher nominal wages as an increase in real wages, and decide to work longer, harder, and generally increase the quantity of their labor supplied. However, they could be misperceiving their real wage if the price level has also increased. And it is likely to be increasing because other firms throughout the economy are also increasing production and prices in response to the booming economy. This is a temporary situation because resource owners eventually realize that the price level has increased. Alternatively, workers' higher nominal wages can actually increase real wages because the prices of other goods have not yet increased. The economy is dynamic, complex, and diverse. All prices do not change simultaneously. All production does not expand at the same time. The Wacky Willy Company could be at the forefront of an economic boom. It might take a few months or even years before other firms expand and raise their prices. Until they do, Wacky Willy workers might be experiencing a true, albeit short term, increase in real wages that does in fact justify greater production. This imbalance in real wages can also affect The Wacky Willy Company in the face of declining sales. Should The Wacky Willy Company reduce workers' nominal wages, workers see this as a reduction in real wages. Like higher wages, this could be an illusion, because workers do not realize that the price level is also lower, or it could be actual, because many prices that make up the price level have not yet fallen. In either case, they reduce the quantity of labor supplied and The Wacky Willy Company produces fewer Stuffed Amigos. The result of imbalances in real resource prices is that aggregate real production can increase above full employment if the price level is higher and fall below full employment if the price level is less. But these production levels are temporary. Once resource owners realize the price level has changed or once other prices actually do change, then the quantities of resources supplied will adjust back to their full employment levels. And when this happens, real production returns to full-employment production. Check Out These Related Terms... | aggregate supply | short-run aggregate supply | short-run aggregate supply curve | long-run aggregate supply curve | long-run aggregate supply curve | slope, long-run aggregate supply curve | aggregate supply determinants | slope, aggregate demand curve | aggregate market analysis | aggregate market | short-run, macroeconomics | long-run, macroeconomics | Or For A Little Background... | macroeconomics | gross domestic product | price level | macroeconomic markets | supply | supply curve | real gross domestic product | product cost | And For Further Study... | change in aggregate supply | change in real production | aggregate supply shifts | business cycles | circular flow | Keynesian economics | monetary economics | short-run aggregate supply and market supply | Recommended Citation: SLOPE, SHORT-RUN AGGREGATE SUPPLY CURVE, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2024. [Accessed: October 13, 2024]. |