Question

What assumptions cause the immediate-short-run aggregate supply curve to be horizontal? Why is the long-run aggregate supply curve vertical? Explain the shape of the short-run aggregate supply curve. Why is the short-run aggregate supply curve relatively flat to the left of thefull-employment output and relatively steep to the right? LO12.3

Short answer

The immediate-short-run supply curve is horizontal due to sticky prices and wages, while the long-run curve is vertical due to price flexibility and resource efficiency. The short-run curve is flat at outputs below full employment and steep above due to differing resource utilization costs.

Step-by-step solution

Immediate-Short-Run Aggregate Supply Curve Assumptions

In the immediate-short-run, it is assumed that prices of goods and wages are sticky, meaning they do not change quickly in response to changes in demand. Therefore, producers adjust their production levels but not prices, resulting in a horizontal aggregate supply curve.

Long-Run Aggregate Supply Curve Explanation

In the long-run, prices and wages are flexible, allowing the economy to adjust fully to any changes in demand. Thus, the long-run aggregate supply curve is vertical because it represents the full-employment level of output, assuming all factors of production are being used efficiently.

Shape of the Short-Run Aggregate Supply Curve

The short-run aggregate supply curve is upward sloping because while some prices, like wages, may be sticky, many firms adjust prices slowly in response to changes in demand. As output increases, production becomes more costly, leading firms to charge higher prices.

Flatness to the Left of Full-Employment Output

To the left of full-employment output, the short-run supply curve is relatively flat because idle resources, particularly labor, can be employed without causing significant increases in costs, making it easier to raise output.

Steepness to the Right of Full-Employment Output

To the right of full-employment output, the short-run supply curve becomes steep because resources are being used to their maximum capacity, making further increases in output more costly and leading to higher prices.

Key concepts

Immediate-Short-Run Assumptions

In the immediate-short-run, prices for goods and wages are considered to be "sticky." Here's what that means: these prices do not adjust swiftly to changes in demand conditions. Imagine you suddenly want to buy more ice cream. In the immediate-short-run, the price of ice cream won't go up right away. Instead, producers will try to meet this demand by increasing production without changing prices.
This results in a horizontal aggregate supply curve. The focus here is on changing output levels, not prices. This stickiness can happen because it takes time for wages to adjust due to contracts or production costs to change right away.
In practice, this period is very short since prices will eventually adjust, but understanding this concept is crucial to grasping short-run economic dynamics.

Long-Run Aggregate Supply

In the long-run, the economy operates differently. Here, all prices and wages are flexible. Why is that important? Because it means the economy can fully adjust to changes in demand over time. This leads to a vertical long-run aggregate supply (LRAS) curve.
The LRAS curve represents the economy's full-employment output, signifying that all resources are being utilized efficiently. No matter how much demand changes, in the long-run the economy tends to return to this full-employment level of output.
The vertical nature of the curve reflects the idea that while demand can influence production and prices in the short-run, only the economy's resource availability, such as physical capital and labor force, dictates long-run output. Think of it as the economy's "natural" level of production.

Short-Run Aggregate Supply Curve

Unlike the immediate-short-run, in the short-run certain prices, such as wages, can still be sticky. However, other prices may start to adjust. The short-run aggregate supply (SRAS) curve is upward sloping due to this gradual adjustment.
This slope suggests that as output increases, the costs of production, including wages and material costs, also rise. To offset these costs, firms begin to charge higher prices, leading to a positive relationship between the price level and the quantity of goods supplied.
Changes in input prices, technology, or expectations about future prices can shift the SRAS curve, illustrating how various factors influence the economy not immediately, but certainly in the short-run.

Full-Employment Output

Full-employment output is a crucial concept in understanding the shape and behavior of the aggregate supply curve. It marks the level of output where all resources such as labor, capital, and technology are utilized efficiently.
In the context of the short-run aggregate supply curve, to the left of this level, the curve is relatively flat. Why? Because there are more available resources, like unemployed labor and equipment, thus increasing output doesn't significantly raise production costs.
Conversely, to the right of the full-employment output, the curve becomes steep. This steepness occurs because all resources are already being used, and more output requires expensive additional resources or overtime pay, causing production costs to rise sharply. Understanding these dynamics helps to explain how economies adjust to changes in demand and resource availability over time.