Economics 020 Lecture 12 6 October, 1997

Aggregate Demand and Aggregate Supply AD-AS equilibrium

Aggregate Supply The sum of the quantities of all the final goods produced in the economy is called the aggregate quantity of goods and services produced It is measured by real GDP Aggregate supply is the relationship between the quantity of real GDP supplied and the price level

Aggregate Supply We distinguish two time frames for aggregate supply: Long-run aggregate supply Short-run aggregate supply

Long-Run Aggregate Supply Long-run aggregate supply is the relationship between the quantity of real GDP supplied and the price level when real GDP equals potential GDP Potential GDP is real GDP when all the economy’s labor, capital, land, and entrepreneurial ability are fully employed

Long-Run Aggregate Supply The long-run aggregate supply curve LAS, is vertical at potential GDP

Long-Run Aggregate Supply A movement along the LAS curve, means that two sets of prices are changing: the price level the money wage rate

Long-Run Aggregate Supply Because both the price level and the money wage rate change, the real wage rate remains constant.

Long-Run Aggregate Supply The real wage rate remains at the level that achieves full employment of labor

Short-Run Aggregate Supply Short-run aggregate supply is the relationship between the quantity of real GDP supplied and the price level when the money wage rate and all other influences on production plans remain constant Fig. 24.4 shows short-run aggregate supply

Short-Run Aggregate Supply The short-run aggregate supply (SAS) curve is upward-sloping At a price level of 120, the quantity of real GDP supplied is $500 billion

Short-Run Aggregate Supply At a price level of 130, the quantity of real GDP supplied is $600 billion, which equals potential GDP

Short-Run Aggregate Supply At a price level of 140, the quantity of real GDP supplied is $700 billion, which exceeds potential GDP

Short-Run Aggregate Supply The SAS curve slopes upward because, when the price level rises with a constant money wage rate, firms make a larger profit by producing a larger output

Movements Along LAS and SAS A rise in both the price level and the money wage rate that maintains full employment brings a movement along the LAS curve

Movements Along LAS and SAS A rise in both the price level at a constant money wage rate brings a change in employment and real GDP and a movement along the SAS curve

Changes in Aggregate Supply Long-run aggregate supply changes when potential GDP changes. And potential GDP changes for two basic reasons: aggregate labor hours (at full employment) increases labor productivity increases

Changes in Aggregate Supply Labor productivity increases for three reasons: growth of the capital stock growth of human capital technological change

Changes in Aggregate Supply Short-run aggregate supply changes for all the reasons that long-run aggregate supply changes In addition, short-run aggregate supply changes when the money wage rate changes

Changes in Aggregate Supply When potential GDP increases, both LAS and SAS shift rightward

Changes in Aggregate Supply When the money wage rate rises, the SAS curve shifts leftward but the LAS curve remains unchanged

Short-Run Equilibrium Short-run equilibrium occurs when the quantity of real GDP demanded equals the quantity of real GDP supplied Short-run equilibrium occurs at the point of intersection of the AD curve and the SAS curve

Short-Run Equilibrium If the price level exceeds 130, the quantity of real GDP supplied exceeds the quantity of real GDP demanded

Short-Run Equilibrium Because there is a surplus of goods and services, firms cut prices and decrease production

Short-Run Equilibrium If the price level is below 130, the quantity of real GDP demanded exceeds the quantity of real GDP supplied

Short-Run Equilibrium Because there is a shortage of goods and services, firms raise prices and increase production

Short-Run Equilibrium If the price level equals 130, the quantity of real GDP demanded equals the quantity of real GDP supplied

Short-Run Equilibrium Because there is neither a surplus nor a shortage of goods and services, firms keep prices production constant

Short-Run Equilibrium When equilibrium real GDP is below potential GDP, there is a recessionary gap Here, the recessionary gap is $100 billion

Short-Run Equilibrium When equilibrium real GDP equals potential GDP, there is a full employment Here, the full employment is at a real GDP of $600 billion

Short-Run Equilibrium When equilibrium real GDP exceeds potential GDP, there is an inflationary gap Here, the inflationary gap is $100 billion

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