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Lecture 17

ECO 1102 Lecture Notes - Lecture 17: Potential Output, Aggregate Supply, Longrun

Course Code
ECO 1102
Najib Khan

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Chapter 14-Part 2
Why the Long-Run Aggregate-Supply Curve Might Shift Natural rate of output: the production of
goods and services that an economy achieves in the long run when unemployment is at its normal rate
Potential output Full-employment output Changes in labor Changes in capital Changes in
natural resources Changes in technological knowledge
Using Aggregate Demand and Aggregate Supply to Depict Long-Run Growth and Inflation With the
introduction of the aggregate-demand curve and the long-run aggregate-supply curve we are now in a
position to describe the economy’s long-run trends
Why the Aggregate-Supply Curve Slopes Upward in the Short Run In the short run, the price level does
affect the economy’s output. An increase in the overall level of prices tends to raise the quantity of
goods and services supplied and vice versa.
Why do changes in the price level affect output in the short run? Macroeconomists have proposed
three theories for the upward slope of the short-run aggregate supply curve.
The Sticky Wage Theory The Sticky Price Theory The Misperceptions Theory
All three theories suggest that output deviates from its natural rate when the price level deviates
from its expected level. Mathematically, this is expressed as:
Quantity of output supplied = Natural rate of output + a (Actual price level expected price level)
Where a is the number that determines how much output responds to unexpected changes in the
price level.
SUMMARY In the long run, wages and prices are flexible rather than sticky and people are not
confused about relative prices.
Quantity of output supplied = Natural rate of output
Why the Short-Run Aggregate-Supply Curve Might Shift We can think of the short-run aggregate-
supply curve as similar to the long-run aggregate-supply curve but made upward sloping by the presence
of sticky wages, sticky prices, and misperceptions. When thinking about what shifts the short-run
aggregate supply curve, we have to consider all those variables that shift the long-run aggregate-supply
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