Download Long run Aggregate Supply

Long run Aggregate Supply
(completing the AD/AS model)
introduction
The concept of long-run aggregate supply (LAS) must be developed
before we can understand how inflation and unemployment are
determined by the economy.
We will portray the notion of the LAS curve differently from the way
Gottheil does in his text. In Gottheil's text the aggregate supply
curve becomes vertical at the level of real GDP that defines full
employment.
From page 176 of Gottheil's Principles of Macroeconomics 3e:
I think it is better to conceive of the AS curve becoming vertical when
the economy reaches its physical limit, not full employment. It is
possible to produce output levels beyond full employment for some
period of time. These high levels of real GDP cannot be maintained
indefinitely, but can be reached.
With Gottheil's conception, the economy can never produce beyond
full employment -- the frictionally and structurally unemployed cannot
be enticed to work for higher wages. The way we will develop our
Notes:
LAS will explain our full employment economy better than the
manner in which Gottheil does.
natural rate of unemployment
recall:
full employment -- a level o f output for which the number of jobs
created equals the number of qualified persons available to fill the
jobs. This is equilibrium in the labor market. People are frictionally
and structurally unemployed. There is no cyclical unemployment.
another wa y to state full employment is in terms of the rate of
unemployment:
natural rate of unemployment -- unemployment rate at which there is
an approximate balance between the number of unfilled jobs and the
the number of qualified job seekers. This is the unemployment rate
associated with the full employment level of output.
natural rate of unemployment is due to frictional and structural
conditions of the labor market -- it is sustainable in the future -- it
may be maintained.
macroeconomic short-run and long-run
macroeconomic short-run -- length of time for which only prices of
goods and services change, but the prices of resources do not
change
Wages account for approximately 70% all costs. Hence, for our
purposes, the short-run is the length of time for which wages are
constant. Labor costs will be our focus
macroeconomic long-run -- length of time sufficient for for prices of
all resources to change
The long-run is the length of time it takes for wages to change.
summary: short-run -- wages fixed
long-run -- wages completely flexible -- perfect wage and
price flexibility
Notes:
short-run aggregate supply (AS)
short-run aggregate supply -- the relationship between the aggregate
quantity of goods and services produced (real GDP) and the price
level when resource prices are held constant (wages)
short-run aggregate supply curve -- plots the relationship between
real GDP supplied and the price level holding wage rates constant
This is simply the intermediate or "normal" range of our AS curve we
developed earlier when we discussed the three ranges of levels of
employment when we were giving the basics of the AS curve.
The curve has a positive slope because as firms attempt to increase
the amount of product they produce (output if one considers products
in aggregate ), they must offer higher wages to entice workers to
their industry. This is the reason the curve has a positive slope, but
for this graph wages are assumed to constant -- if wages change the
AS curve will shift.
long-run aggregate supply (LAS)
long-run aggregate supply -- relationship between the aggregate
quantity of goods and services (real GDP) and the price leve l when
the level of output is full employment
When a sufficient amount of time has passed for wages to adjust to
changing labor market conditions -- the long-run will be attained
long-run aggregate supply curve -- plots the relationship between
real GDP and the price level when wages are completely flexible and
hence full employment obtains
Notes:
Notes:
The LAS is vertical at the full employment level o f output. Wages
have time to fully adjust and the changes in costs from the wage
changes are passed on to consumers in the form of price changes.
Gottheil's model has no contingency for the long run. To compare
Gottheil's perspective (simplified some from ours - not completely
inconsistent) to the model we will be adopting:
To compare Gottheil's model with ours:
Notes:
types of macroeconomic equilibrium
There are three basic types of macroeconomics equilibrium.
Macroeconomic equilibrium is judged according to the relationship of
the equilibrium level of output to the long run aggregate supply curve
(which is located at the full employment level of real GDP).
The animated diagram below explains the three types of equilibrium.
It also shows the relationship of our AD-AS model to the business
cycle. You can trace the business cycle for the United States
economy and illustrate what was happening in the economy at any
specific point in time with the AD-AS model.
It "seems" to run slow.
Notes:
automatic adjustment process
If the equilibrium level of real GDP is exactly equal to the full
employment level of real GDP, a long run equilibrium has obtained.
There is no tendency for change. In the model, ceteris paribus, the
equilibrium would remain for all eternity! The economy would never
expand or contract. Of course, that world is only the world of the ADAS model. In the real world something always changes.
If the equilibrium level of real GDP is not equal to the full
employment level of real GDP, the equilibrium level of real GDP will
change automatically! Real GDP will adjust toward the long run
equilibrium without any discretionary action by the Federal Reserve
or the federal government. This is a big deal.
Notes:
preview of AD-AS
A common example of the AD-AS model is an increase in AD. The
model will need to be "fleshed out" over the next couple of weeks,
but be the end of the quarter you will be able to understand and
conduct an analysis similar to the following example.