Aggregate Supply Macroeconomic Theory Continued Aggregate Supply Curve

Aggregate Supply Macroeconomic Theory 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 • 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 fullemployment Definition: – LRAS is vertical at level of “natural rate of output” This level of production is also called: potential output or full-employment output

Long-Run AS Curve Price Level LRAS Real Output Does NOT Change! P P 2 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 3 rd theory in Textbook— misperceptions theory)

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

Sticky Wages in Action Business sign 2 -year contract to pay Workers $20/ hour Price Level Suddenly rises Wages are cheap in “real dollars” Firm will increase supply

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

Conclusion • Output deviates only in short run when actual price level deviates from expected price level • In long run, wages & prices are not “sticky” and do not affect output (price level has no effect) – Prices/wages become flexible!

Worksheet • Shapes of AS Curves P 1 --------- Y 1 E 1