1. Aggregate Supply
Module 18

2. Short-Run Aggregate Supply (SRAS)
Upward sloping, just as in market case
But again for different reasons
Profits = Price of Outputs – Price of Inputs
Revenue generated by price increases outpaces increases in input costs (wages are “sticky”)
So, in the short-run curve slopes upwards
Reverse is also true

4. Changes in SRAS Changes in commodity prices Changes in nominal wages
Oil; steel
Decrease in commodity prices = increase in SRAS
Changes in nominal wages
Increase in nominal wages = decrease in SRAS
Change in productivity
Increases in productivity = increase in SRAS

5. Figure Shifts of the Short-Run Aggregate Supply Curve Ray and Anderson: Krugman’s Macroeconomics for AP, First Edition Copyright © 2011 by Worth Publishers

6. Long-Run Aggregate Supply (LRAS)
In the longer term, “sticky” input prices “catch up” to output prices
Therefore, in the long run, price level should have no affect on aggregate supply
So, aggregate supply would be a vertical line

8. Long-Run Aggregate Supply
What is the significance of the output value (Y) at which the LRAS is vertical?
The answer is the economy’s potential output YP
This represents the level at which the economy would produce if all prices (including wages) were perfectly flexible

9. Figure The Long-Run Aggregate Supply Curve Ray and Anderson: Krugman’s Macroeconomics for AP, First Edition Copyright © 2011 by Worth Publishers

10. Figure Actual and Potential Output from 1989 to 2009 Ray and Anderson: Krugman’s Macroeconomics for AP, First Edition Copyright © 2011 by Worth Publishers

11. Short Run v. Long Run
At any given point in time, the economy is on the the short-run aggregate supply (SRAS) curve
Since the long-run aggregate supply (LRAS) curve is a vertical line, the SRAS will intersect it at some point
Events that shift the SRAS, will shift the point at which the SRAS and LRAS intersect

12. Shifts in SRAS Changes in Commodity Prices Changes in Nominal Wages
Steel; Oil
Decrease in commodity prices; SRAS shifts right
Changes in Nominal Wages
Decrease in nominal wages; SRAS shifts right
Changes in Productivity
Increase in commodity prices; SRAS shifts right

13. Figure From the Short Run to the Long Run Ray and Anderson: Krugman’s Macroeconomics for AP, First Edition Copyright © 2011 by Worth Publishers

14. Macroeconomic Equilibrium The AD-AS Model
Module 18

15. Figure The AD–AS Model Ray and Anderson: Krugman’s Macroeconomics for AP, First Edition Copyright © 2011 by Worth Publishers

16. Demand Shocks
Expectations
Wealth
Stock of productive capital

17. Figure Demand Shocks Ray and Anderson: Krugman’s Macroeconomics for AP, First Edition Copyright © 2011 by Worth Publishers

18. Supply Shocks
Commodity prices
Nominal wages
Productivity

19. Figure Supply Shocks Ray and Anderson: Krugman’s Macroeconomics for AP, First Edition Copyright © 2011 by Worth Publishers

20. Figure Long-Run Macroeconomic Equilibrium Ray and Anderson: Krugman’s Macroeconomics for AP, First Edition Copyright © 2011 by Worth Publishers

21. Figure Short-Run Versus Long-Run Effects of a Negative Demand Shock Ray and Anderson: Krugman’s Macroeconomics for AP, First Edition Copyright © 2011 by Worth Publishers

22. Figure Short-Run Versus Long-Run Effects of a Positive Demand Shock Ray and Anderson: Krugman’s Macroeconomics for AP, First Edition Copyright © 2011 by Worth Publishers

23. Calculating the Gap
To calculate the % value of a inflationary or recessionary gap: Output Gap = Actual Aggregate Output – Potential Output x 100 Potential Output

24. In the long run… The value of all gaps will tend towards zero
In recessionary gaps, wages will fall and SRAS will increase
In inflationary gaps, wages will rise and SRAS will decrease

25. Example Short run equilibrium? Long run equilibrium? What kind of gap?
LRAS
Short run equilibrium?
Long run equilibrium?
What kind of gap?
If Y1 = 160 and YP= 200 what is the output gap?
What will happen over time?
Agg.
Price
Level AD
SRAS E P1
Yes. AD=SRAS at Y1
No. Not equal to potential output
Recessionary gap: Y1 < YP
( )/200 = -40/200 = -20%
Wages will decline leading to an increase in SRAS. Output will increase to match potential output at a lower Aggregate Price Level. Y1
Real GDP