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The Long Run Aggregate Supply Curve The Long run AS curve represents the economy at its full employment/natural rate of unemployment level. It is the.

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Presentation on theme: "The Long Run Aggregate Supply Curve The Long run AS curve represents the economy at its full employment/natural rate of unemployment level. It is the."— Presentation transcript:

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2 The Long Run Aggregate Supply Curve The Long run AS curve represents the economy at its full employment/natural rate of unemployment level. It is the level of output that an economy can produce if all of its resources are fully employed.

3 The Long-Run Aggregate Supply Curve uIn the long-run, an economys production of goods and services depends on its supplies of labor, capital, and natural resources and on the available technology used to turn these factors of production into goods and services. uThe price level does not affect these variables in the long run.

4 The Long-Run Aggregate- Supply Curve... Quantity of Output Natural rate of output Price Level 0 Long-run aggregate supply P1P1 P2P2 2. …does not affect the quantity of goods and services supplied in the long run. 1. A change in the price level…

5 Why the Long-Run Aggregate Supply Curve Might Shift uShifts arising from Labor uShifts arising from Capital uShifts arising from Natural Resources uShifts arising from Technological Knowledge

6 1. In the long- run, technological progress shifts long-run aggregate supply... LRAS 2000 LRAS 1990 Long-Run Growth Quantity of Output Price Level 0 Y 1980 LRAS 1980 Y 1990 Y …leading to growth in output...

7 SHORT RUN AGGREGATE SUPPLY Short-run aggregate supply measures current production within our economy –It is determined by current price levels and two factors The cost of production –Input prices –Productivity levels (technology) –Legal-institutional factors (taxes and government regulations) Changes in the expected price level

8 SHORT RUN AGGREGATE SUPPLY There are three reasons why the Short run Aggregate Supply curve is upward sloping. Sticky wages - as prices rise wages may be slow to follow, allowing business owners to profit from higher prices. Sticky prices- all prices do not rise simultaneously. A business that is slow to raise their prices may sell more in the short run. Misperceptions of price increases – a business owner may assume incorrectly that the increase in price level is the result of an increase in demand for THEIR product and therefore increase production.

9 o AS 1 P1P1 P2P2 Q1Q1 Q2Q2 a1a1 a2a2 A higher price level increases profits and output moving the economy from a 1 to a 2 Price Level Real domestic output SHORT-RUN AGGREGATE SUPPLY

10 o AS 1 P1P1 P2P2 Q1Q1 Q2Q2 a1a1 a2a2 A lower price level decreases profits and output moving the economy from a 1 to a 3 Price Level Real domestic output SHORT-RUN AGGREGATE SUPPLY P3P3 Q3Q3 a3a3

11 Why the Short-run Aggregate Supply Curve Might Shift uShifts arising from a change in Labor costs. uShifts arising from a change in Capital costs. uShifts arising from a change in Natural Resource costs. uShifts arising from a change in Technology. uShifts arising from a change in the Expected Price Level.

12 1. An adverse shift in the short-run aggregate-supply curve… AS 2 Long-run aggregate supply Short-run aggregate supply, AS 1 Quantity of Output Price Level 0 Aggregate demand A Y1Y1 P1P1 A Decrease in Aggregate Supply …and the price level to rise. P2P2 2. …causes output to fall… B Y2Y2

13 An Increase in Aggregate Supply Quantity of Output Price Level 0 Short-run aggregate supply, AS 1 Aggregate demand, AD 1 A P1P1 Y1Y1 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. P2P2 B AS 2 Y2Y2 Long-run aggregate supply

14 Expected Inflation and Actual Inflation nThe short-run trade-off between unemployment and inflation exists only because of misperceptions about the actual rate of inflation. nIn other words actual inflation may be different from expected inflation. nIf actual inflation is higher than what workers expected there will be an increase in output and a decrease in unemployment.

15 o AS 1 P1P1 P2P2 Q1Q1 Q2Q2 a2a2 a1a1 Price Level Real domestic output Expected versus Actual Inflation – higher than expected price levels increase output AS LR

16 uWhen people expect an increase in price levels they tend to set wages high. This shifts the short-run aggregate supply curve to the left. uWhen people expect a decrease in price levels the tend to set wages low. This shifts the short-run aggregate supply curve to the right. Shifts Arising from a Change in Expected Price Level

17 o AS 1 P1P1 P2P2 Q1Q1 Q2Q2 a2a2 a1a1 AS 2 b1b1 Price Level Real domestic output AGGREGATE SUPPLY IN THE SHORT AND LONG-RUN A higher expected price level results in higher nominal wages and thus shifts the short-run aggregate supply to the left. The result is higher prices, but a return to the original level of output.

18 o P3P3 Q3Q3 AS 1 P1P1 P2P2 Q1Q1 Q2Q2 a2a2 a3a3 a1a1 b1b1 AS 3 c1c1 AS LR Price Level Real domestic output A lower expected price level reduces nominal wages and shifts the short-run aggregate supply to the right. This results in lower prices, but a return to the original level of output. AS 2 AGGREGATE SUPPLY IN THE SHORT AND LONG-RUN

19 AGGREGATE SUPPLY IN THE SHORT AND LONG-RUN Period in which nominal wages (and other input prices) remain fixed as the price level increases or decreases Short Run - Period in which nominal wages are fully responsive to previous changes in the price level Long Run -


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