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Slope of the Aggregate Supply
Curve
The general law of diminishing returns
partially accounts for the upward slope of supply curves for individual firms
and for market supply curves. Additional production eventually becomes ever
more costly as output levels grow. Thus, firms may require higher prices to
justify expanding their outputs. Moreover, higher prices embody greater
incentives for firms to produce more output because profit opportunities are
enhanced. A similar logic applies for the economy as a whole.
• Capacity and Price–Cost
Dynamics The
positive slope of this Aggregate Supply curve reflects the fact that prices
adjust more rapidly than production costs; costs are relatively more
“sticky.” When the price level rises, delayed hikes in costs yield profit
incentives to expand production.
Idle resources become less available when
higher employment presses against a society’s productive capacity. The prices
a firm can charge in a growing economy tend to rise faster than its resource
costs. Thus, profit per unit of output grows during a business upturn. Firms
naturally respond by producing and selling more goods. But prices tend to
fall faster than costs when business activity slows down, and profit per unit
of output may even become negative. Firms facing declining profit margins may
drastically cut back production and lay off workers to cut their costs.
For example, an increase in the demand for
food at your local supermarket would cause movement along its supply curve.
The manager will order more goods and quickly mark up prices. Grocers will
also hire more workers. Employees’ wages and other costs will rise, but much
less rapidly than prices, so total profits will swell. What happens if this
demand collapses? The prices the grocer charges will fall much faster than
wages or other production costs. Profits plummet, so grocery workers will
lose their jobs.
Conclusion?
Production costs per unit are much slower to adjust to changes in Aggregate
Demand than are the prices of output. This is the major reason why a
society’s Aggregate Supply is positively sloped in the short run, as shown in
the figure above.
• National Output and the Work Force National output expands when
more workers become employed, but because of diminishing returns, beyond some
point, extra workers decreasingly add to total output. Labor markets are based
on supply and demand, much like markets for goods. Higher wages may induce
greater effort or attract more people into the labor force, or the unemployed
may find acceptable positions after shorter periods of joblessness. Thus,
unless the economy is extremely slack, supply curves for labor have a
positive slope.
When
aggregate output is low and unemployment is high (output below Qf
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