Transcript long-run aggregate supply curve

Chapter 10
Aggregate
Demand and
Aggregate Supply:
The Basic Model
Short-Run Macroeconomic Equilibrium
• The forces of short-run aggregate supply and
aggregate demand meet at an equilibrium price
level in an environment of incomplete
adjustment of wages and prices.
Short-Run
Macroeconomic Equilibrium (cont’d)
• If the price level is below the equilibrium level:


Aggregate quantity demanded is greater than
aggregate quantity supplied.
Firm’s inventories will decline.

Firms will respond by increasing both production and
price.

The higher price level reduces the aggregate
quantity demanded.

Process continues until equilibrium is reached.
Short-Run
Macroeconomic Equilibrium (cont’d)
• If the price level is above the equilibrium level:


Aggregate quantity supplied is greater than
aggregate quantity demanded.
Firm’s inventories will increase.

Firms will respond by decreasing both production
and price.

The lower price level increase the aggregate quantity
demanded.

Process continues until equilibrium is reached.
Figure 10.5(a)
Short-Run Macroeconomic Equilibrium
Figure 10.5(b)
Short-Run Macroeconomic Equilibrium
Characteristics of Short-Run Equilibrium
• If an economy is in short-run equilibrium, it will
stay there unless there are changes in the
behavior of suppliers, households, firms,
governments or the foreign sector.
• If an economy is not in short-run equilibrium,
the forces of aggregate demand and aggregate
supply will cause the economy to move to
equilibrium.
Characteristics of
Short-Run Equilibrium (cont’d)
• Combination of price level and output where
there is no incentive to change their behavior.
• But it may not represent optimal economic
conditions.


May not be consistent with the full-employment level
of GDP.
Adjustment to short-run equilibrium may result
in inflation.
Can we do it?
• Let’s try number 10…
• Consider the following
information about AD and
SR AS in a macroeconomy:
Price
AD
SR AS
125
300
600
120
350
550

At which prices are there
surpluses? At which prices
are there shortages?
115
400
500

What is the equilibrium price
level? What is the SR
equilibrium level of output?
110
450
450
105
500
400
100
550
350
95
600
300

Draw the AD and SR AS
curve and label the
equilibrium price and quantity.
The Basics of
Long-Run Aggregate Supply
• The long-run aggregate supply curve
is the level of output that occurs at fullemployment production in the economy
after all adjustments to changing prices
have occurred.
Figure 10.7
The Long-Run Aggregate Supply Curve
Shape of the
Long-Run Aggregate Supply Curve
• Vertical because it reflects the complete
adjustment by all of the participants in the
economy to changing prices.

In the long run:
• Firms will have no incentive to change output in response to
changes in the price level, because
• Nominal wages and other resources prices will move with
the price level.
Location of the
Long-Run Aggregate Supply Curve
• Located at full-employment real GDP.

Level of output achieved when there are complete
and accurate adjustments by all participants in the
economy in the long run.
Movement of the
Long-Run Aggregate Supply Curve
• The determination of full employment real GDP
is similar to the determination of the maximum
amount of output shown by the production
possibilities frontier.

The same factors that shift the PPF outward
will shift the long-run aggregate supply curve to the
right:
• Improvements in technology
• Increases in other resources
Figure 10.8 Production Possibilities
Frontier and Long-Run Aggregate Supply
Long-Run Macroeconomic Equilibrium
• Intersection of the aggregate demand curve
with both the short-run aggregate supply curve
and the long-run aggregate supply curve.
Figure 10.9 Long-Run Equilibrium
Long-Run
Macroeconomic Equilibrium
• The long-run equilibrium is optimal in that:

There is no over- or under-production in
the economy.

The economy is producing all of the output it is
capable of producing.

There is full employment.

There is no upward or downward pressure on the
price level.

All participants in the economy have obtained
enough information to adjust their behavior
accordingly.
Chapter 10 homework
• Numbers 4, 7, 11, 12 and 18