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I. Aggregate Supply a. Long-run vs short-run b. Short-run AS (SRAS) - movement along SRAS vs a change in SRAS - determinants of SRAS c. Long-run AS (LRAS) Short Run AS vs Long Run AS Recall: In microeconomics, the short-run is defined as a period of time in which something remains fixed In Macro: The short-run is a period in which nominal wages (and other input prices) are fixed as the price level changes. Why are wages fixed in the short-run? 1. Fixed wage contracts for managers and professionals Ex: Many jobs have annual reviews of workers 2. Workers are not immediately aware that inflation or deflation has changes their real wages Ex: When you go to store, the prices of some items have increased, but other items might be on sale. It may take a year for you to realize: My grocery bill has increased $20 and my rent also went up. The Long-run – a period in which input prices (wages) are fully responsive to changes in the price level. Ex: Contracts expire Workers realize that they have experienced a in real wages and ask for raise. Aggregate Supply - shows the effect of changes in the price level on the quantity of goods and svcs that firms are willing able to supply (real GDP supplied). - NOTE: there are 2 AS curves!!!!! 1. short-run AS (SRAS) 2. long-run AS (LRAS) A) short-run AS (SRAS) Shows the short-run relationship between P and real GDP supplied Is upward sloping P real GDP supplied Why is SRAS upward sloping? 1. In the short-run, nominal wages (and the price of other inputs) adjust slowly. Recall: In the short-run workers have not yet asked for raises (they haven’t realized that prices have increased or not time for annual contract review). Also, firm’s vendors who supply inputs to production have not consistently increased prices. wages and prices are sticky in the short-run (they don’t respond quickly) 2. menu costs- Therefore, in the short-run, if the overall price of final goods and svcs ( P) profit and increased willingness to supply goods to the market. Note: or in P will only produce a movement along SRAS curve (A B). A shift in SRAS vs a movement along it Note: A change in the price level (P) will cause a change in the quantity of real GDP supplied Inflation and deflation cause a movement along the SRAS curve A shift in SRAS Caused by a change in one of the determinants of SRAS An increase in SRAS: A decrease in SRAS: Determinants of SRAS Long-run AS (LRAS) * Shows the long-run relationship between P and real GDP supplied * Recall, the long-run is a period in which input prices (wages) are fully responsive to changes in the price level. * Also recall: Full employment cyclical unemployment = 0 There is frictional & structural unemployment Both are natural phenomenon Full employment is called the natural rate of unemployment Potential GDP (QP)– the quantity of real GDP at full employment. - A nation’s output when all of their economic resources (L, L, C, & EA) are fully employed. ** Potential GDP is also called full-employment GDP In the long-run, 1. firms will operate at full capacity and everyone who wants a job will find one (only frictional and structural unemp). 2. changes in the price level (P) do not effect the level of real GDP. the LRAS is vertical at full employment GDP (QP) Understanding the Vertical LRAS Short run effects of P: Suppose QP potential GDP. If there is an P movement along SRAS Since this is the short-run, nominal wages don’t (& other factor prices don’t ). Note: Inflation temporarily makes real GDP above potential GDP. Long run effects: However, when workers discover that P & ask for raises SRAS (as prices of other factors also ) Note: real GDP to QP The factors that cause LRAS to are the factors that we learned that cause real GDP to : 1. labor 2. capital 3. technological change