Presentation on theme: "The Long Run Aggregate Supply Curve"— Presentation transcript:
1The 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.
2The Long-Run Aggregate Supply Curve In the long-run, an economy’s 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.The price level does not affect these variables in the long run.
3The Long-Run Aggregate- Supply Curve... Price LevelLong-runaggregatesupplyP11. A change in the price level…2. …does not affect the quantity of goods and services supplied in the long run.P2Natural rateof outputQuantity ofOutput
4Why the Long-Run Aggregate Supply Curve Might Shift Shifts arising from LaborShifts arising from CapitalShifts arising from Natural ResourcesShifts arising from Technological Knowledge
5Long-Run Growth Price Level LRAS19801. In the long-run, technological progress shifts long-run aggregate supply...LRAS2000LRAS1990Y1990Y20002. …leading to growth in output...Y1980Quantity ofOutput
6SHORT RUN AGGREGATE SUPPLY Short-run aggregate supply measures current production within our economyIt is determined by current price levels and two factorsThe cost of productionInput pricesProductivity levels (technology)Legal-institutional factors (taxes and government regulations)Changes in the expected price level
7SHORT 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.
8SHORT-RUN AGGREGATE SUPPLY A higher price level increases profits and output moving the economy from a1 to a2AS1P2a2Price LevelP1a1oQ1Q2Real domestic output
9SHORT-RUN AGGREGATE SUPPLY A lower price level decreases profits and output moving the economy from a1 to a3AS1P2a2Price LevelP1a1P3a3oQ3Q1Q2Real domestic output
10Why the Short-run Aggregate Supply Curve Might Shift Shifts arising from a change in Labor costs.Shifts arising from a change in Capital costs.Shifts arising from a change in Natural Resource costs.Shifts arising from a change in Technology.Shifts arising from a change in the Expected Price Level.
11A Decrease in Aggregate Supply... 1. An adverse shift in the short-run aggregate-supply curve…AS2PriceLevelLong-runaggregatesupplyShort-run aggregatesupply, AS12. …causes output to fall…BY23. …and the price level to rise.P2AP1Aggregate demandY1Quantity ofOutput
13Expected Inflation and Actual Inflation The short-run trade-off between unemployment and inflation exists only because of misperceptions about the actual rate of inflation.In other words actual inflation may be different from expected inflation.If actual inflation is higher than what workers expected there will be an increase in output and a decrease in unemployment.
14Price Level o Real domestic output Expected versus Actual Inflation – higher than expected price levels increase outputASLRAS1P2a2a1Price LevelP1oQ1Q2Real domestic output
15Shifts Arising from a Change in Expected Price Level When people expect an increase in price levels they tend to set wages high. This shifts the short-run aggregate supply curve to the left.When people expect a decrease in price levels the tend to set wages low. This shifts the short-run aggregate supply curve to the right.
16Price Level o Real domestic output AGGREGATE SUPPLY IN THE SHORT AND LONG-RUNA 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.AS2b1AS1P2a2a1Price LevelP1oQ1Q2Real domestic output
17Price Level o Real domestic output AGGREGATE SUPPLY IN THE SHORT AND LONG-RUNA 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.ASLRAS2b1AS1P2a2AS3a1Price LevelP1P3a3c1oQ3Q1Q2Real domestic output
18AGGREGATE SUPPLY IN THE SHORT AND LONG-RUNShort Run -Period in which nominal wages (and other input prices) remainfixed as the price level increases or decreasesLong Run -Period in which nominal wages are fully responsive to previous changes in the price level