1. Copyright © 2004 South-Western Mods 17-21, 30 Macro Analysis Part II

2. Copyright © 2004 South-Western THE AGGREGATE-SUPPLY CURVE Now, let’s look at Overall or AGGREGATE Supply…

3. Copyright © 2004 South-Western The Basic Model of Economic Fluctuations The Basic Model of Aggregate Supply The aggregate-supply curve shows the quantity of goods and services that firms choose to produce and sell at each price level.

4. Copyright © 2004 South-Western The Short-Run Aggregate-Supply Curve GDP=Quantity of Output Price Level 0 Short-run aggregate supply 1. A decrease in the price level... 2.... reduces the quantity of goods and services supplied in the short run. Y P Y2Y2 P2P2 Copyright © 2004 South-Western

5. Why the Aggregate-Supply Curve Slopes Upward in the Short Run In the short run, an increase in the overall level of prices in the economy tends to raise the quantity of goods and services supplied. A decrease in the level of prices tends to reduce the quantity of goods and services supplied.

6. Copyright © 2004 South-Western Why the Aggregate-Supply Curve Slopes Upward in the Short Run There are 2 reasons for why the AS curve slopes upward in the short run…

7. Copyright © 2004 South-Western Why the Aggregate-Supply Curve Slopes Upward in the Short Run 1. The Sticky-Wage Theory Nominal wages are slow to adjust, or are “sticky” in the short run: A lower price level makes employment and production less profitable. This induces firms to reduce the quantity of goods and services supplied. Wages do not adjust immediately to a fall in the price level—there is a lag, while the wages “stick” So…there will be movement downward on the AS curve until wages are adjusted

8. Copyright © 2004 South-Western Why the Aggregate-Supply Curve Slopes Upward in the Short Run 2. The Sticky-Price Theory Prices of some goods and services adjust sluggishly in response to changing economic conditions: An unexpected fall in the price level leaves some firms with higher-than-desired prices—prices are temporarily “stuck” This depresses sales, which induces firms to reduce the quantity of goods and services they produce. Eventually, prices will be changed, to match the overall price level and movement on the curve will stop

9. Copyright © 2004 South-Western Shifts in the Aggregate SupplyCurve Quantity of Output Price Level 0 Aggregate Supply S 1 P1P1 Y1Y1 Y2Y2 Aggregate Supply S 2

10. Copyright © 2004 South-Western Why the Short-Run Aggregate-Supply Curve Might Shift Shifts arising from: Labor—changes in labor prices (wages) Capital—changes in equip/facilities Natural Resources—changes in commodity prices Technology—changes in tech

11. Copyright © 2004 South-Western Why the Aggregate-Supply Curve Might Shift Aggregate Supply Shifts worksheet

12. Copyright © 2004 South-Western Model used to analyze economic fluctuations The AD-AS Model

13. Copyright © 2004 South-Western Short-Run Macroeconomic Equilibrium Price Level Aggregate Output Shortage/Surplus

14. Copyright © 2004 South-Western Shifts of Aggregate Demand: Short-Run Effects Demand Shock Negative Demand Shock Positive Demand Shock

15. Copyright © 2004 South-Western Shifts of the SRAS Curve Supply Shock Negative Supply Shock Stagflation Positive Supply Shock

16. Copyright © 2004 South-Western Shifts of the SRAS & AD Curves Shifts Practice Worksheet