Transcript Long Run Aggregate Supply

SHORT-RUN AND LONG-RUN
AGGREGATE SUPPLY
Short Run Period in which nominal wages
(and other input prices) remain
fixed as the price level increases
or decreases
Long Run -
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Period in which nominal wages
are fully responsive to previous
changes in the price level
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AGGREGATE DEMAND AND AGGREGATE SUPPLY
SHORT-RUN AGGREGATE SUPPLY
A higher price level increases profits and
output moving the economy from a1 to a2
AS1
Price Level
P2
P1
o
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a2
a1
Q1
Q2
Real domestic output
AGGREGATE DEMAND AND AGGREGATE SUPPLY
2
SHORT-RUN AGGREGATE SUPPLY
A lower price level decreases profits and
output moving the economy from a1 to a3
AS1
Price Level
P2
P1
P3
o
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a2
a1
a3
Q3
Q1
Q2
Real domestic output
AGGREGATE DEMAND AND AGGREGATE SUPPLY
3
LONG RUN AGGREGATE SUPPLY
A higher price level results in higher nominal
wages and thus shifts the short-run aggregate
supply to the left
ASLR AS2
Price Level
P2
P1
o
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b1
AS1
a2
a1
Q1
Q2
Real domestic output
AGGREGATE DEMAND AND AGGREGATE SUPPLY
4
LONG RUN AGGREGATE SUPPLY
A lower price level results reduces nominal
wages and shifts the short-run aggregate
supply to the right
ASLR AS2
b1
Price Level
P2
AS3
a1
P1
P3
o
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AS1
a2
a3
Q3
c1
Q1
Q2
Real domestic output
AGGREGATE DEMAND AND AGGREGATE SUPPLY
5
Why the LRAS Curve Might Shift
Any event that
changes any of the
determinants of YN
will shift LRAS.
P
LRAS1 LRAS2
Example:
Immigration
increases L,
causing YN to rise.
YN
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Y’
N
AGGREGATE DEMAND AND AGGREGATE SUPPLY
Y
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Using AD & AS to Depict LR Growth and
Inflation
Over the long run,
tech. progress shifts
LRAS to the right
and growth in the
money supply shifts
AD to the right.
Result:
ongoing inflation
and growth in
output.
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P
LRAS2000
LRAS1990
LRAS1980
P2000
P1990
AD2000
P1980
AD1990
AD1980
Y1980
Y1990
Y2000
AGGREGATE DEMAND AND AGGREGATE SUPPLY
Y
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Economic Fluctuations
 Caused by events that shift the AD and/or
AS curves.
 Four steps to analyzing economic fluctuations:
1. Determine whether the event shifts AD or AS.
2. Determine whether curve shifts left or right.
3. Use AD-AS diagram to see how the shift
changes Y and P in the short run.
4. Use AD-AS diagram to see how economy
moves from new SR eq’m to new LR eq’m.
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AGGREGATE DEMAND AND AGGREGATE SUPPLY
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Two Big AD Shifts:
1. The Great Depression
U.S. Real GDP,
billions of 2000 dollars
From 1929-1933,
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700
650
600
550
AGGREGATE DEMAND AND AGGREGATE SUPPLY
1934
u-rate rose
from 3% to 25%
750
1933
P fell 22%
800
1932
Y fell 27%
850
1931
•
•
•
stock prices fell 90%,
reducing C and I
900
1930
•
money supply fell
28% due to problems
in banking system
1929
•
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Two Big AD Shifts:
2. The World War II Boom
2,000
Y rose 90%
1,400
P rose 20%
1,200
unemp fell
from 17% to 1%
1,000
1,800
1,600
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AGGREGATE DEMAND AND AGGREGATE SUPPLY
1944
1943
1942
800
1939
•
•
•
govt outlays rose
from $9.1 billion
to $91.3 billion
1941
•
U.S. Real GDP,
billions of 2000 dollars
1940
From 1939-1944,
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The Effects of a Shift in AD
Event: stock market crash
P
1. affects C, AD curve
LRAS
2. C falls, so AD shifts left
3. SR eq’m at B.
P and Y lower,
unemp higher
4. Over time, PE falls,
SRAS shifts right,
until LR eq’m at C.
Y and unemp back
at initial levels.
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SRAS1
A
P1
P2
SRAS2
B
P3
AD1
C
AD2
Y2
YN
AGGREGATE DEMAND AND AGGREGATE SUPPLY
Y
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ACTIVE LEARNING
Exercise
2:
 Draw the AD-SRAS-LRAS diagram
for the U.S. economy,
starting in a long-run equilibrium.
 A boom occurs in Canada.
Use your diagram to determine
the SR and LR effects on U.S. GDP,
the price level, and unemployment.
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ACTIVE LEARNING
Answers
2:
Event: boom in Canada
P
1. affects NX, AD curve
LRAS
SRAS2
2. shifts AD right
3. SR eq’m at point B.
P and Y higher,
unemp lower
P3
4. Over time, PE rises,
SRAS shifts left,
until LR eq’m at C.
Y and unemp back
at initial levels.
P1
C
SRAS1
B
P2
A
AD2
AD1
YN
Y2
Y
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The Effects of a Shift in SRAS
Event: oil prices rise
1. increases costs,
P
shifts SRAS
(assume LRAS constant)
2. SRAS shifts left
3. SR eq’m at point B.
P2
P higher, Y lower,
unemp higher
P1
From A to B,
stagflation,
a period of
falling output
and rising prices.
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LRAS
SRAS2
SRAS1
B
A
AD1
Y2 YN
AGGREGATE DEMAND AND AGGREGATE SUPPLY
Y
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Accommodating an Adverse Shift in SRAS
If policymakers do nothing,
4. Low employment
causes wages to fall,
SRAS shifts right,
until LR eq’m at A.
Or, policymakers could
use fiscal or monetary
policy to increase AD
and accommodate the
AS shift:
Y back to YN, but
P permanently higher.
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P
LRAS
SRAS2
P3
P2
P1
C
B
A
SRAS1
AD2
AD1
Y2 YN
AGGREGATE DEMAND AND AGGREGATE SUPPLY
Y
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