1. Extending the Analysis of16
C H A P T E R
Extending the Analysis of
Aggregate Supply

2. 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 -
Period in which nominal wages are fully responsive to previous changes in the price level

3. SHORT-RUN AGGREGATE SUPPLY
A higher price level increases profits and output moving the economy from a1 to a2
AS1 P2 a2
Price Level P1 a1 o Q1 Q2
Real domestic output

4. SHORT-RUN AGGREGATE SUPPLY
A lower price level decreases profits and output moving the economy from a1 to a3
AS1 P2 a2
Price Level P1 a1 P3 a3 o Q3 Q1 Q2
Real domestic output

5. 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 b1
AS1 P2 a2 a1
Price Level P1 o Q1 Q2
Real domestic output

6. 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
AS1 P2 a2
AS3 a1
Price Level P1 P3 a3 c1 o Q3 Q1 Q2
Real domestic output

7. EQUILIBRIUM IN THE EXTENDED AD-AS MODEL
ASLR
AS1
Price Level P1 a
AD1 o Q1
Real domestic output

8. DEMAND-PULL INFLATION
ASLR
AS2
AS1 c P3
Price Level P2 b P1 a
AD2
AD1 o Q1
Real domestic output

9. COST-PUSH INFLATION Occurs when short-run AS shifts left Price Level o
ASLR
AS2
AS1
Price Level P2 b P1 a
AD1 o Q2 Q1
Real domestic output

10. COST-PUSH INFLATION Even higher price levels
Government response with increased AD
ASLR
AS2
AS1
Even
higher
price
levels c P3
Price Level P2 b P1 a
AD2
AD1 o Q2 Q1
Real domestic output

11. COST-PUSH INFLATION If government allows a recession to occur
ASLR
AS2
AS1
Price Level P2 b P1 a
AD1 o Q2 Q1
Real domestic output

12. COST-PUSH INFLATION If government allows a recession to occur Nominal
ASLR
AS2
AS1
Nominal
wages fall &
AS returns
to its original
location
Price Level P2 b P1 a
AD1 o Q2 Q1
Real domestic output

13. THE INFLATION-UNEMPLOYMENT
RELATIONSHIP
Normally, there is a short-run trade-off between the rate of inflation and the the rate of unemployment
Aggregate supply shocks can cause both higher rates of inflation and higher rates of unemployment
There is no significant trade-off over long periods of time

14. Price Level o Real domestic output
EFFECT OF CHANGES IN AGGREGATE DEMAND
ON REAL OUTPUT AND THE PRICE LEVEL
AD0 AS
Price Level P0 o Q0
Real domestic output

15. Price Level o Real domestic output
EFFECT OF CHANGES IN AGGREGATE DEMAND
ON REAL OUTPUT AND THE PRICE LEVEL
AD0
AD1 AS
Price Level P1 P0 o Q0 Q1
Real domestic output

16. Price Level o Real domestic output
EFFECT OF CHANGES IN AGGREGATE DEMAND
ON REAL OUTPUT AND THE PRICE LEVEL
AD0
AD1
AD2 AS
Price Level P2 P1 P0 o Q0 Q1 Q2
Real domestic output

17. Price Level o Real domestic output
EFFECT OF CHANGES IN AGGREGATE DEMAND
ON REAL OUTPUT AND THE PRICE LEVEL
AD0
AD1
AD2
AD3 AS P3
Price Level P2 P1 P0 o Q0 Q1 Q2 Q3
Real domestic output

18. Annual rate of inflation Unemployment rate (percent)
THE PHILLIPS CURVE CONCEPT 7 6 5 4 3 2 1
As inflation declines...
Unemployment
increases
Annual rate of inflation
(percent)
Unemployment rate (percent)

19. GLOBAL PERSPECTIVE 1990 1995 2000 The Misery Index, Selected Nations
Italy
U.K. 15 10 5
Canada
France
U.S.
Germany
Japan
1990
1995
2000
Source: Bureau of Labor Statistics

20. Aggregate-Supply Shocks Short-Run Phillips Curve
THE LONG-RUN PHILLIPS CURVE
Stagflation’s Demise
Aggregate-Supply Shocks
Short-Run Phillips Curve
Long-Run Vertical Phillips Curve
Disinflation

21. Taxes and Incentives to Work Incentives to Save and Invest
TAXATION AND AGGREGATE SUPPLY
Taxes and Incentives to Work
Incentives to Save and Invest
Supply-Side Economics
Laffer Curve

22. THE LAFFER CURVE
100
Tax rate (percent) l
Tax revenue (dollars)

23. THE LAFFER CURVE
100
Tax rate (percent) m l
Tax revenue (dollars)

24. THE LAFFER CURVE
100 n
Tax rate (percent) m l
Tax revenue (dollars)

25. THE LAFFER CURVE Maximum Tax Revenue Tax rate (percent)
100 n
Tax rate (percent) m m
Maximum
Tax
Revenue l
Tax revenue (dollars)

26. Chapter Conclusions Taxes, Incentives, and Time Inflation
Criticisms of the Laffer Curve
Taxes, Incentives, and Time
Inflation
Position on the Curve
Chapter Conclusions

27. KEY TERMS short run long run short-run aggregate supply curve
long-run aggregate supply curve
Phillips Curve
stagflation
aggregate supply shocks
long-run vertical Phillips curve
disinflation
supply-side economics
Laffer Curve
Copyright McGraw-Hill/Irwin, 2002
BACK
END

28. Up next...
Economic Growth and
the New Economy
Chapter 17