11 February 2013
CHAPTER 23: OUTPUT AND PRICES IN THE SHORT RUN
Derivation of the Aggregated Supply (AS)
To complete the model, we need to derive the aggregate supply curve. The aggregate supply (AS) curve
represents the amount of output that firms are willing to produce at each price level. In
macroeconomics, the slope of the AS curve depends on:
Level of unemployment
Time horizon (IE: Short-run vs. long-run)
It is because we are looking at the entire economy not just one industry, the big picture matters
CASE 1: IF THERE IS A LOT OF UNEMPLOYMENT (IN THE SHORT RUN)
This means Y* is much lower than YFE. Firms will be willing to supply more even if price does not
increase much. Since there are quite a large number of unemployed workers, firms would find it easy to
hire workers if they want to expand. Besides, firms probably have unused facilities. The AS curve will be
relatively flat (IE: Elastic).
CASE 2: IF THERE IS NOT MUCH UNEMPLOYMENT (IN THE SHORT RUN)
This means Y* is close to YFE. Firms will it difficult to increase supply even if price increases. Firms may
find it difficult to hire additional workers, especially good, productive workers. Besides, it may not be
feasible to have the existing workers work over time. The AS curve will be relatively steep (IE: Inelastic).
Sometimes we simplify the AS curve as follow:
Vertical AS curve in the long run (when Y = FE)
Horizontal AS curve in the immediate run
In the meantime, we assume AS curve is upward sloping in the
short run, firms are willing to produce more when price rises. AS
curve is vertical in the long run.
YFEepends on technology, labour force, and stock of capital.
SRAS depends on production cost
Putting AS and AD Together
AD is derived from setting AE(P) to Y at different price levels. For
the AS curve, there is a positive relationship between prices and
the amount of output produced by firms (in the short run).
Short-Run Equilibrium is given by the intersection of AS and AD.
Pt A is the equilibrium in the D-AS model Adjustment Process of the AS-AD Model
Use the linked diagram to show the adjustment process, what brings the economy back to its (short-run)
CASE 1: INITIAL PRICE IS BELOW EQUILIBRIUM PRICE, P < P* 0