Aggregate Supply Curve and Microeconomic Supply Curve

AGGREGATE SUPPLY CURVE AND MICROECONOMIC SUPPLY CURVE 3

AggregateSupply Curve and Microeconomic Supply Curve

AggregateSupply Curve and Microeconomic Supply Curve

TheAS (Aggregate supply) curve outlines the relationship that existsbetween the quantity of output provided by business entities or firmsand price levels. It is represented in the equation d W = d P(prices) = -k (u – u*), where u* would be the natural rate ofunemployment and u represents the current unemployment. An increasein price would result in an increase in output in the short run,while real wages reduce in the medium run. The workers would ask fornominal wages, which increase the prices and lower the output to theoriginal level or lower levels in instances where workersmiscalculate wages (Mankiw,2012).In microeconomic context, the supply curve of the firm is a componentof the marginal cost curve which is plotted above average cost. Inperfectly competitive industry, firms change their production to themarginal cost curve that allows for maximization of profits (P=MC).An increase in price would result in above-normal profits and P&gtMC,which increase the short-run supply resulting in a shift in thesupply curve to the right so as to match demand. This increasesoutput and quantity for firm and the market (Mankiw,2012).Of particular note is the fact that the quantity for the firm wouldnot increase, as the high profits pushes the factor prices up therebyaffecting industry expansion and increasing the prices of factors(rent on capital and wages). This would increase average cost andlower the output. However, since other firms may provide the sameproducts, the market supply remains unaffected even as there is areduction in per unit output. Other firms will be driven to themarket by the profits, thereby increasing supply so as to matchdemand, in which case the output of firms reverts to the originallevel in which P=MC, where there will be no losses or profits(Mankiw,2012).This happens since AS is only aggregated to the economy and does notbecome aggregated MC for every other firms.

References

Mankiw,N. G. (2012).&nbspPrinciplesof macroeconomics.Mason, OH: South-Western Cengage Learning.