Download Aggregate Supply Changes and the Economy

Chapter 14 -- Aggregate Supply
and Economic Growth
This chapter -- looks at the effects
of changes in Aggregate Supply,
both short-run and long-run.
Correspondingly, we examine the
causes that shift the AS curve and
the LAS curve, and their effects on
the economy.
Short-Run
Aggregate Supply (AS)
Short-Run Aggregate Supply (AS)
-- the sum of all the newly
produced US final goods and
services that firms wish to
produce (real GDP supplied), given
inflexible input prices (especially
the nominal wage rate).
Short-Run Aggregate
Supply (AS) -- Causes
Price Level (P)
P  AS
Price of Energy (PE)
PE  AS
The Nominal Wage Rate (W)
W  AS
Short-Run Aggregate
Supply -- More Causes
Labor Productivity (PROD), defined as
output per labor hour.
PROD  AS
Capital Stock (K) -- all the existing
physical plant and equipment used by
firms to produce goods and services.
K  AS
Formalizing the AS Curve
Upward sloping when graphed against
Price Level (P).
Changes in a cause other than P -described as shifting the AS curve.
Changes in variables that increase AS,
or enhance production, shift the AS
curve rightward.
Changes in variables that decrease AS,
or hinder production, shift the AS curve
leftward.
Example 1 -A Supply Shock
Example 1 -- The price of energy (PE)
increases (energy crisis in US, 1973
and 1979).
PE hinders production, reduces ShortRun Aggregate Supply.
Therefore the AS curve shifts leftward.
As a result, Y*, P* (Yuck!!).
Example 2 -- Productivity:
The “Magic” Variable
Example 2 -- Labor productivity
(PROD) increases (late 1990s, 2000
in US).
PROD increases Short-Run
Aggregate Supply.
Therefore the AS curve shifts
rightward.
As a result, Y*, P* (Wow!!).
Example 3 -The Wage-Price Spiral
Example 3 -- Two Changes.
(1) Increases in (G - T) (increase in
government purchases, or decrease
in taxes) move Y* beyond YF and
accelerate inflation.
(2) Labor wants their wages to keep
pace with inflation, so they get
larger than normal wage increases
(W).
Describing The Wage-Price
Spiral -- AD-AS Model
(1) Increase in (G - T) shifts AD curve
rightward, Y* beyond YF, P*.
(2) The rise in W is described by a
shift of the AS curve leftward.
As a result Y* returns to its previous level,
P* even more.
Creates a situation called Stagflation –
inflation with stagnant output.
Tends to be a continuing process,
i.e. “spiral”.
The Long-Run Aggregate
Supply (LAS) Curve
Vertical when plotted versus the
price level (P).
Vertical at the full sustainable level
of real GDP (YF)
Shifting the LAS Curve
Curve shifts either rightward
(increase in LAS) or leftward
(decrease in LAS)
Variables that shift the LAS curve
rightward, therefore, increase YF.
Variables that shift the LAS curve
leftward, therefore, decrease YF.
Shift Variables – LAS Curve
(Variables That Change YF)
Labor Productivity (PROD)
PROD  LAS
Capital Stock (K) -- all the existing
plant and equipment used by firms
to produce goods and services.
K  LAS
More Shifters – LAS Curve
(Variables That Change YF)
Size of Labor Force
Labor Force  LAS
Tastes/Preferences Toward Work.
Work  LAS
Transfer Payments (TP)
TP  LAS
Application #1 – What
Makes YF Grow in the US?
Steady Growth in the Following
Variables:
Labor Force
Capital Stock Accumulation
Labor Productivity
Average Growth of YF in US:
2.5% per year
Not the same for all countries in
the world.
Application #2 – Effects
of a Productivity Boom
Suppose that increased
technology (e.g.
computerization) makes labor
more productive.
Productivity growth increases,
shifts LAS curve rightward
more than usual.
Application #2
Continued -- Effects on YF
Therefore YF in the US grows at
more than 2.5%.
This implies that actual real GDP
(Y*) can enjoy higher growth
without accelerating inflation.
Very nice!!
Goals for the Economy
Fluctuations -- seek to get the
economy (Y*) as close to possible
to a given YF (examples: standard
fiscal and monetary policy)  shift
AD curve.
Economic Growth -- seek to
increase the full sustainable level
of real GDP (YF)  shift LAS curve.
Ways to Increase Economic
Growth (Increase YF)
Capital Stock
Labor Productivity
Labor Force
Household Attitudes Toward
Work
Transfer Payments
Trying to Increase
Labor Productivity
Increase Research and Development.
Increase Labor Quality (Human Capital)
– Education and Vocational Training.
Promote Investment (plant and
equipment)!!!
-- Tends to Incorporate New
Technology.
-- Also expands the capital stock.