Transcript Document

Lesson 7-2
Aggregate Supply
Aggregate Supply: the Long Run and The
Short Run
Basic Definitions
The short run in macroeconomic analysis is a
period in which wages and some other prices are
sticky.
A sticky price is a price that is slow to adjust to its
equilibrium level, creating sustained periods of
shortage or surplus.
The long run in macroeconomic analysis is a
period in which wages and prices are flexible
The Long Run
Long-run Aggregate Supply
The long-run aggregate supply curve relates the level
of output produced by firms to the price level in the long
run.
In the long run, the economy can achieve its natural
level of employment and potential output at any price
level.
The long-run aggregate supply curve (LRAS) is a
vertical line at the economy’s potential level of output (Y
P ).
The Long Run (cont.)
Equilibrium Levels of Price and Output in the Long Run
The intersection of long-run aggregate demand and longrun aggregate supply gives the equilibrium real GDP and
price level in the long run.
Shifts in aggregate demand only result in price level
changes in the long run.
The Short Run
Short-Run Aggregate Supply
A shift in aggregate demand in the short run will be
accompanied by some sticky prices.
An increase in aggregate demand will probably
increase the prices firms receive but not the wages
they must pay.
Firms will probably want to increase output.
Some formerly frictionally and structurally
unemployed workers may be employed to allow such
increases in production.
Thus, output can be above the potential or natural
output temporarily until the wages rise to
accommodate the increase in aggregate demand.
A decrease in aggregate demand in the short run will
probably cause a reduction in prices received by
firms but no change in the wage rates. This leads to
laying off workers and reducing output below the
potential level until the wages adjust to the lower
aggregate demand.
The short-run aggregate supply curve is a graphical
representation of the relationship between production
and the price level in the short run.
The short-run aggregate supply curve (SRAC) is
upward-sloping because of sticky wages and some
prices.
Among factors held constant in drawing a short-run
aggregate supply curve are the capital stock, the stock
of natural resources, the level of technology, and the
prices of factors of production.
The movement along the short-run aggregate supply
curve produced by a change in the price level is called
a change in the aggregate quantity of goods and
services supplied.
A change in the quantity of goods and services
supplied at every price level in the short run is a
change in short-run aggregate supply.
Changes in the factors held constant in drawing the
short-run aggregate supply curve shift the curve and
may also shift the long-run aggregate supply curve as
well.
Reasons for Wage and Price Stickiness
Wage Stickiness
Wage contracts fix nominal wages for a set period,
sometimes several years.
Minimum wages prevent some wages from falling.
Price Stickiness
Rigidity of wages may cause firms to resist
changing prices.
There may be adjustment costs associated with
changing prices.