>> Let's talk about
aggregate supply:

why it is shaped the way it
is and what can shift it.

The best way to get confused in
economics is to forget what is

on the axis of your graph.

For aggregate demand
and aggregate supply,

the whole economy's output,
GDP, is on the horizontal axis,

and the whole economy's price
level is on the vertical axis.

The first thing to know
about aggregate supply is

that there's two kinds:
long run aggregate supply

and short run aggregate supply.

In the long run, aggregate
supply is vertical.

That's because the nation's
price level has no impact

on supply in the long run.

Instead, supply is determined
by the amount of labor we have,

the amount of capital we have,

and how efficient those
productive resources are.

And the only things that can
shift the long run aggregate

supply are changes in the
amount or the efficiency

of those productive resources.

Then there is short
run aggregate supply.

In the short run, higher
prices will induce firms

to supply more, while lower
prices will induce them

to supply less.

So why does short run
aggregate supply slope upwards?

First, we have to understand how
firms make production decisions.

A firm's profits
are the difference

between the price it receives
for its output and the cost

of producing that output.

If profits are low,
firms produce less

and if profits are
high, they produce more.

One reason that the short run
aggregate supply curve might

slope up is if product prices
can move freely, but wages --

which make up the main
production cost for most firms,

don't change right away.

This is called the
sticky wage theory.

As the price level goes up, but
production costs don't change,

firms become more profitable
and produce more output.

Likewise, if prices fall, but
production costs don't change,

profits are squeezed
and firms produce less.

A second reason that the short
run aggregate supply curve might

slope up is called the
sticky price theory.

Here, the idea is
that some firms fail

to change their output prices to
match the overall price level.

If the general price
level rises,

but one firm's price is the
same, customers will reward

that firm by buying more,
increasing that firm's output.

Likewise, if the general
price level falls,

but one firm doesn't cut its
prices, it will lose customers

and have to cut its output.

A final reason why the short
run aggregate supply might slope

upwards is called the
misperceptions theory.

Firms always change their
output in response to changes

in the prices of their products.

The idea here is that they
mistake a general rise in prices

for a price change
specific to their product

and they raise their output.

Or they mistake a general
fall in prices for a change

in price specific to their
product and cut their output.

So, what could shift the
short run aggregate supply?

Two things.

First, the factors that shift
the long run aggregate supply

curve will also shift the short
run aggregate supply curve --

changes in the amount
of labor, capital,

or their technological
efficiency.

Second, expectations of a higher
general price level will shift

short run aggregate supply
inwards; while expectations

of a lower general price level
will shift short run aggregate

supply outwards.