Answer to Question #148535 in Macroeconomics for John

Question

What are the assumptions of the possible shape of the aggregate supply curve?

Answer 1

Solution:

The immediate short-run supply curve is horizontal because of contractual agreements. These 'contracts' for both input and output prices imply that prices do not change along the immediate short-run aggregate supply curve.

The long-run aggregate supply curve is vertical (at the full-employment or potential output) because the economy's potential output is determined by the availability and productivity of real resources, not by the price level. The availability and productivity of real resources is reflected in the prices of inputs, and in the long run these input prices (including wages) adjust to match changes in the price level.

The shape of the short-run supply curve is upsloping. Wages and other input prices adjust more slowly than the price level, leaving room for firms to take advantage of these higher prices (temporarily) by increasing output. Firms face increasing per unit production costs as they increase output, making higher prices necessary to induce them to produce more.

To the left of full-employment output the curve is relatively flat because of the large amounts of unused capacity and idle human resources. Under such conditions, per-unit production costs rise slowly because of the relative abundance of available input

To the right of full-employment output the curve is relatively steep because most resources are already employed. Those resources that are not yet in production require higher prices to induce them, or generate higher per-unit production costs because they are less productive than currently employed inputs