23115 Chapter Notes - Chapter 6: Aggregate Demand, Nominal Rigidity, Menu Cost
Aggregate Demand and Supply II
Short Run Aggregate Supply:
The SRAS is upwards sloping - over the prior of 1-2 years, price increases cause and increase in
goods and services supplied.
If Aggregate Supply is vertical (LRAS), fluctuations in Aggregate Demand do not cause fluctuations
in output or employment. If Aggregate Supply slopes up (SRAS), shifts in Aggregate Demand affect
output and employment.
Output deviates from its natural rate when the actual price level deviates from the expected price
level.
Aggregate Supply Theories:
1. Sticky Wage Theory: nominal wages are sticky in the short run, they adjust sluggishly to
influences. Firms and workers set the nominal wage in advance based on price expectations. If
price exceeds expectations, revenue is higher but labour cost is not, so firms increase output and
employment
2. Sticky Price Theory: Prices are sticky in the short run due to the cost adjusting prices eg menus.
Firms set sticky prices in advance based on price expectations. If the money supply increases
unexpectedly, price will rise in the long run, but in the short run firms without menus can raise
prices immediately. Firms with menu costs wait to raise prices, stimulating demand for products, so
they increase output and employment.
3. Misperceptions Theory: Firms may confuse changes in price with changes in the relative price of
the products they sell. If prices rise above price expectations, a firm sees its price rise before
retailing all prices are rising, believing relative prices are rising an increase output and
employment.
In consequence, an increase in price causes an increase in income, making SRAS curse upward
sloping. In all theories, income deviates from income expectations when price deviates from price
expectations
Output = Natural Rate of Output + Income response to changes in Price (Actual Price - Expected
Price) or Y = Yn + a(P - Pe)
The imperfections of Aggregate Supply Theories are temporary; over time, sticky wages and prices
become flexible, and misperceptions are corrected. In the long run, price equals price expectations
and the Aggregate Supply Curve is vertical.
Anything that shift the LRAS shifts the SRAS also, such as an increase in price expectations.
In the long-run equilibrium, price equal expectations and income equals natural income, and
unemployment is at its natural rate.
find more resources at oneclass.com
find more resources at oneclass.com
Document Summary
The sras is upwards sloping - over the prior of 1-2 years, price increases cause and increase in goods and services supplied. If aggregate supply is vertical (lras), uctuations in aggregate demand do not cause uctuations in output or employment. If aggregate supply slopes up (sras), shifts in aggregate demand affect output and employment. Output deviates from its natural rate when the actual price level deviates from the expected price level. Aggregate supply theories: sticky wage theory: nominal wages are sticky in the short run, they adjust sluggishly to in uences. Firms and workers set the nominal wage in advance based on price expectations. If price exceeds expectations, revenue is higher but labour cost is not, so rms increase output and employment: sticky price theory: prices are sticky in the short run due to the cost adjusting prices eg menus. Firms set sticky prices in advance based on price expectations.
