Download Aggregate Supply & Demand

Aggregate Supply
AD/AS Model Continued
Aggregate Supply Curve
• Aggregate-supply curve (AS)- how supply of goods &
services for the entire economy changes with inflation
– quantity of goods & services all firms produce at each price level
Price
Level
Gov’t ↓ Taxes => consumer income ↑
AS1
P2
---------------
------------------
-------------------- E2
P1 --------------- E1
Y1
Y2
C ↑ => AD ↑ => R-GDP ↑
AD2
AD1
Real
GDP
AD = C + I + G + NX
Worksheet
Different Shapes of AS Curves
Px
Level
Px
Level
AS
Real
GDP
AS
Real
GDP
Px
Level
AS
Real
GDP
Aggregate Supply Curve
• Aggregate-supply curve (AS)- how supply of goods &
services for the entire economy changes with inflation
• Short run curve (SRAS) is upward sloping
• Long Run curve (LRAS) is vertical
Determinants of Real GDP
• In long run, economy’s output depends on quantity of:
–
–
–
–
Labor
Capital,
Natural resources
Technology
• In long run, Price level does not affect these variables
Price Level is related only to
Quantity of Money
Natural Rate of Output
•
Level of Real GDP economy achieves in long run at
full-employment (full potential output)
Definition:
– LRAS is vertical at level of “natural rate of output”
Also called:
Full potential output
or
Full-employment output
Conditions: On PPF curve & at full employment
Qty
Food
.
(0,100)
.
.
C
B
(50,50)
A
(100, 0)
Qty
Shelter
Long-Run AS Curve
Price
Level
LRAS
Real Output
Does NOT
Change!
P
P2
A change in
price level
0
Inflation Doubles:
Does NOT affect
Qty of goods/services
supplied
Natural rate
of output
Full Employment
Output
Real GDP
Why is the Short Run AS Curve upward sloping?
• 2 Primary Theories:
– Sticky-Wage Theory
– Sticky-Price Theory
– (you can ignore 3rd theory in Textbook— misperceptions theory)
Price
Level
Aggregate
SRAS1
supply
Equilibrium
P1
price level
AD1
Aggregate
demand
0
Equilibrium
Y
output
Real
GDP
Sticky-Wage Theory
• Nominal wages are slow to adjust to changing economic conditions
– Wages are “sticky” in short run
•
Example:
Price level falls => Nominal wages do not adjust immediately
– Production is now less profitable because wages are artificially high
– So firms reduce quantity of goods & services supplied
Price
Level
Aggregate
SRAS1
supply
Equilibrium
P1
price level
AD1
Aggregate
demand
0
Equilibrium
Y
output
Real
GDP
Sticky Wages in Action
Price
Level
Aggregate
SRAS1
supply
Business sign 2-year contract
to pay Workers $20/ hour
Equilibrium
P1
price level
AD1
Aggregate
demand
0
Price Level
Suddenly rises
Equilibrium
Y
output
Wages are cheap
in “real dollars”
Firm will increase
supply
Real
GDP
Sticky Price Theory
• Prices of some goods & services adjust sluggishly in response
to changing economic conditions
• An unexpected fall in price level leaves some firms with
higher-than-desired prices
– This depresses sales, which induces firms to supply less
AS/AD Model Review
LRAS1
Price
Level
P1
-----------------
SRAS1
E1
AD1
Y1
Real
GDP