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 curve relatively flat to the left of the full-employment output and relatively steep to the right?

Short answer

The contractual agreement assumption causes the immediate short-run aggregate supply curve to be horizontal.

The long-run aggregate supply curve represents the full employment situation; thus, it is vertical.

The short-run aggregate supply curve slopes upward as with the increase in the price level, the supply also increases. The producers find it profitable to supply more when the price level rises.

The short-run curve is flat to the left of the full-employment output is because resources are not used efficiently and steep to the right because most of the resources are used.

Step-by-step solution

Aggregate supply curve to be horizontal

The aggregate supply curve is horizontal because of the assumption of contractual agreement. The contract shows the input and output price; the price does not change along the immediate-short-run aggregate supply curve. The input and output prices are put over the contract; thus, it takes time in the short run to change. The system takes time to absorb the changes and then react; hence, the price does not change immediately in the short run.

Long-run aggregate supply curve

The long-run aggregate supply curve is vertical, representing the full employment situation. The output is determined based on the availability of resources in the long run. After this level, the firms have no incentive to increase production to take higher prices as the input prices will also rise. Thus, the long-run supply curve is vertical.

Short-run aggregate supply curve

The short-run aggregate supply curve slopes upward. In the short run, the wages and price tend to adjust slowly; the producers grab the opportunity of higher prices by increasing the production. Thus, a positive relationship exists between the price and output supplied; hence, the short-run supply curve slopes upward.

Short-run curve before and after the full employment level

The short-run curve before the full employment level is flat as the economy has not utilized the resources fully. With the idle resources when employed, there is a slow rise in the cost of production as resources are abundant; thus, the short-run curve is flat in this situation. After the full employment level, the short-run curve is steep as almost all resources are employed. The unused resources require higher costs as they are less productive than the resources used. In this situation, adding more resources gives a very minimal increase in output; thus, the short-run curve is steep.