Aggregate Supply & Aggregate Demand

Aggregate Supply

AS refers to amt of goods and services produces in an economy.
AS = f(Price Level)
In short run, inputs are fixed and in long run all factors of production can be adjusted. SRAS is constructed holding the money wage(not the real wage) constant.
Key factor in workers' wage demand is expectation for future inflation rates. If expectation for future inflation rates increases then workers demand higher wages
=> Employers produce less at each price level when wages are higher => decrease in SRAS

LRAS: It is the supply of G&S at each price level when inflation expectations=Actual inflation
Increase in inflation that does not change the workers' expectations => doesnt change the SRAS
Change in actual inflation keeping the wages constant => movement along the SRAS curve to temp disequilibrium situation.
In LR, inflation expectations=Actual inflation => Economic production at full employment GDP(LRAS). As the inflation expectations adjust and equal Actual inflation, the SRAS curve shift in a way that the equib shift towards the LRAS.

LRAS is not affected by the price level, bur depends on:

1. Quantity of Labor in the economy
2. Quantity of Capital(productive resources) in the economy
3. The Technology that economy possesses

Movement along the SRAS curve only when the prices of G&S are allowed to vary keeping the wage rate and price of the other productive resources constant in short run.
When prices of G&S fall => businesses have incentive to increase the expand the production which can increase the real GDP above full-employment level(LRAS).

SRAS & LRAS will shift when full emp quantity of labor changes, amt of available capital changes or as technology improves the productivity capital, labor, or both.

If wage rate or other production input change => shift in SRAS.
Factors that change the money wages

1. Unemployment: It increases=> lower wages due to oversupply of labor.
2. Inflation expectations

Aggregate Demand

AG = C+I+G+X (Exp-Imp)

At higher price levels CIG Exp will are decrease. AG is downward sloping:

1. When price levels increase=> individual's real wealth decreases, since they have less accumulated wealth, they will spend less (Wealth effect).
2. When price levels increase=> int rates will increase > Decrease in I and C as consumers delay the consumption of consumer durables since cost of consuming now instead of later has increased.
   

Shift in AD:

1. Expectation about the future incomes, inflation and profits
2. Fiscal and Monetary policies
3. World economy

Increase inflation > increase in AD as consumers accelerate purchases to avoid higher prices in the future.Expectation of increase in income will cause consumption to increase.Increase in expected prices will lead businesses to increase investment in plant and equipment.
Effect of world economy: As the foreign incomes increase, demand for country's exports will increase => increasing X. If country's exchange rate increases (currency appreciates),goods will be costlier to foreigners and exports will decrease. This will decrease imports also since, imported goods will be costlier for domestic market.