Download short-run AS curve

Chapter 23
Prices and Real
Output
in the Short
Run
Introduction to Economics (Combined
Version) 5th Edition
The Aggregate Demand Curve
 The AD curve shows the
relationship between total
real planned expenditure on
final goods and the average
price level of final goods.
 The curve has a negative
slope because each of the
major components of real
AD—C, Ip, G, and EX-IM—
varies inversely with the
price level of final goods.
Introduction to Economics (Combined
Version) 5th Edition
Other Things Being Equal and the AD Curve
 Income is not held constant
along the AD curve.
 The following things are held
constant:
 Expectation-related
determinants of planned
expenditure, for example,
consumer confidence and
business confidence
 Policy-related variables,
including both fiscal and
monetary policy
 Economic conditions in the rest
of the world
Introduction to Economics (Combined
Version) 5th Edition
Shifts in the AD Curve
 A change in the price
level causes a movement
along a given AD curve,
other things being equal.
 A change in economic
conditions other than
the price level will cause
a shift in the AD curve.
 Sources of shifts include
 changes in consumer or
business expectations
 changes in monetary or
fiscal policy
 changes in the world
economy.
Introduction to Economics (Combined
Version) 5th Edition
Input Prices and Output Prices
 Output prices mean the
average price level of final
goods, as measured by an
index like the CPI or GDP
deflator.
 Input prices mean the
average price level of
inputs used in production,
including the following:
 wages
 raw materials
 energy, etc.
 Input prices affect output
prices, but not necessarily
immediately
 Important channels by
which input prices and
output prices are linked:
 Some firms outputs are
other firms’ inputs (e.g.,
electric energy, steel)
 Changes in consumer good
prices affect the cost of
living, and indirectly affect
wages
Introduction to Economics (Combined
Version) 5th Edition
The Long-Run AS Curve
 In the long run,
input prices are
expected to adjust
fully to any
changes in output
prices.
 The long-run AS
curve is a vertical
line drawn at the
economy’s natural
level of real
output.
Introduction to Economics (Combined
Version) 5th Edition
The Short-run AS Curve
 In the shortrun, input
prices are not
expected to
adjust
immediately to
changes in
output prices.
 The short-run
AS curve is
positively
sloped.
Introduction to Economics (Combined
Version) 5th Edition
Reasons for Gradual Adjustment
These are some of the
reasons that expected
input prices do not
adjust immediately to
changes in output
prices:
Long-term contracts
Inventories
Incomplete
knowledge
Costs of changing
prices
Introduction to Economics (Combined
Version) 5th Edition
Shifts in the Short-run AS Curve
 The short-run AS curve
intersects the long-run AS
curve at the expected level
of input prices—the key
“other things being equal”
assumption underlying the
short-run AS curve.
 Over time, a change in the
expected level of input
prices will cause the shortrun AS curve to shift
upward or downward to a
new intersection with the
long-run AS curve.
Introduction to Economics (Combined
Version) 5th Edition
Long-run and Short-run Equilibrium
 The economy is in short-run
equilibrium at the point where the
AD curve intersects the short-run
AS curve.
 It can be in long-run equilibrium
only at a point where the AD curve
intersects the long-run AS curve.
 E0 is a point of both long- and shortrun equilibrium, when the AD curve
is at AD1.
 If the AD curve shifts to AD2, the
short-run equilibrium point moves
to E1 .
 E1 is not a point of long-run
equilibrium because it is not on the
long-run AS curve.
Introduction to Economics (Combined
Version) 5th Edition
Adjustment to an Increase in AD (1)
 Beginning from an initial
long-run equilibrium at E0,
a shift in the AD curve to
AD1 will cause the
economy to move to a
new short-run
equilibrium at E1.
 As it does so,
 real output will rise above
its natural level,
 the price level of final
goods will rise,
 a positive output gap will
develop, and
 unemployment will fall
below its natural rate.
Introduction to Economics (Combined
Version) 5th Edition
Adjustment to an Increase in AD (2)
 After a time, the expected
level of input prices will
adjust to the increase in final
goods prices.
 The short-run AS curve will
shift upward, and the
economy will move up and
to the left along AD1 until it
reaches a new equilibrium at
E3.
 As it does so,
 the price level of final
goods will continue to rise,
 the output gap will
decrease until real output
returns to its natural level,
and
 unemployment will return
to its natural rate.
Introduction to Economics (Combined
Version) 5th Edition
Adjustment to a Decrease in AD (1)
 From this point, starting
from E3 , AD is assumed to
shift back to the position
AD0.
 At first, firms respond to
falling demand and
unexpected inventory
accumulation by cutting
back output and reducing
prices.
 As the economy moves to
a short-run equilibrium at
E4, the unemployment
rate rises and final-goods
prices fall.
Introduction to Economics (Combined
Version) 5th Edition
Adjustment to a Decrease in AD (2)
 When expected input
prices also begin to fall,
the AS curve begins to
shift downward. As it does
so, the economy moves
along AD0, through the
intermediate point E5, and
on down to E0.
 If there is no further
change in AD, the
economy will remain in
equilibrium at that point.
Real Output (billions of dollars per year)
Introduction to Economics (Combined
Version) 5th Edition
AS/AD and the Business Cycle
 Beginning from the natural level of real
output, the economy expands. A positive
output gap develops, unemployment falls
below its natural rate, and the price level
begins to rise.
 After a peak is reached, real output—
although still above its natural level—
begins to decrease and unemployment
begins to increase.
 If AD shifts to the left again after real
output returns to its natural level, the
economy will continue to contract, a
negative output gap will develop, and
unemployment will rise above its natural
rate.
 Eventually real output reaches a minimum,
the trough of the recession. As real output
moves back toward its natural level,
unemployment again decreases.
Introduction to Economics (Combined
Version) 5th Edition