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Lecture 32

Lecture 32-Aggregate Supply Curve

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Jack Carr

Thursday, February 18th, 2010. Economic Facts Year Unemployment Rate 1991 11.0% 2000 6.8% Why? Tools to Analyze AD Schedule* SRAS Schedule* LRAS Schedule (Full-Employment Real GDP) Lectures Text (Lipsey-Ragan) SRAS AS LRAS Potential Output Review 1. Model 2. AD Schedule: Slopes downward (P 9 !$'; Shifts according to the multiplier theory Review 39 ! KRXVHKROGZHDOWK; !&; H[SRUWVPRUHH[SHQVLYH !;; (for given exchange rate) LPSRUWVOHVVH[SHQVLYH !09 (for given exchange rate) Result As price level rises, Aggregate Demand (AD) falls SRAS AD Y P P = Price Level Y = real GDP 3. Next Step: SRAS (short-run aggregate supply schedule) LRAS (long-run aggregate supply schedule) Short-Run Aggregate Supply (SRAS) 1. SRAS: UHODWLRQEHWZHHQUHDO*'3ILUP¶VGHVLUHGSURGXFWLRQ´DQGSULFHOHYHOwhen prices of factors of production (including wages) are constant 2. Price level (P) 9 65$69 ,QWXLWLRQ39Æ higher profits (since wages Æ ILUPV¶GHVLUHG and prices of other factors of production level production do not change) increases SRAS POTENTIAL GDP is total output when factors of production are utilized at normal rates Long-Run Aggregate Supply (LRAS) 1. LRAS: UHODWLRQEHWZHHQUHDO*'3ILUP¶VGHVLUHGSURGXFWLRQDQGSULFHOHYHOZKHQ prices of factors of production (including wages) change in same proportion LRAS: Potential GDP 2. LRAS is vertical because POTENTIAL GDP does not vary with price level (Potential GDP is total output when factors of production are utilized at normal rates) SRAS Real GDP (National Income) Price Level LRAS *Yp = Potential GDP (Full ± Employment GDP) SRAS: Intuition 1. Firm manufactures shirts 2. Signs contracts which - fix wages for one year - fix price of cloth for one year 3. ,ISULFHOHYHOULVHVILUP¶VSURILWVLQFUHDVHVLQFH - price of shirts increases - price of factors of production unchanged 4. Firm responds by increasing production LRAS: Intuition After one year, wages and price RIFORWKLQFUHDVHWRUHIOHFWKLJKHURYHUDOOSULFHOHYHO)LUP¶Vprofits and production return to initial levels Shifts in Aggregate Supply * Given price level, desired production falls ³6XSSO\6KRFN´ SRAS LRAS Increase in productivity (output per worker) due to technological advance Shifts right Shifts right (potential GDP rises) Wages increase Shifts left* (due to reduced profits) No change (real profits unchanged; potential GDP unchanged) LRAS Real GDP (National Income) Price Level Y p Å potential GDP Short-Run Macroeconomic Equilibrium AD = SRAS Long-Run Macroeconomic Equilibrium AD = LRAS (potential GDP) Equilibrium At P = P0: $' 65$6 !$JJUHJDWH'HVLUHG6SHQGLQJ )LUPV¶'HVLUHG2XWSXW Productivity increase SRAS ^Z^[ LRAS P0 Y0 z[p Y0 z[0 >Z^[ Wages increase ^Z^[ SRAS P0 Yp z[0 Y0 >Z^A>Z^[ AD Y0 Real GDP P2 P0 P1 SRAS Disequilibrium At P1 < P0: AD > SRAS => P 9DQG
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