Short Run Aggregate Supply Shifting only SRAS

Sticky Prices/Wages Prices of most goods/services & wages adjust slowly as price level changes This leads to an upward sloping SRAS curve

Sticky Prices/Wages in Action An unexpected rise in the price level (inflation) will leave: Sticky Prices: firms with lower-than-desired prices This increases sales => which induces firms to supply more (↑ Qty of SRAS ) Sticky Wages: workers now have lower real income (nominal wages same) This lowers cost of running the business (↑ Qty of SRAS ) Wages will always LAG inflation in each direction!

Long Run Equilibrium R-GDP only deviates from “full potential” in the short run when actual price level deviates from expected price level This causes recessionary gaps & inflationary gaps to exist Actual price level = current inflation (what you graph) In long run, prices/wages are not “sticky” & do not affect output Actual price level = expected price level Prices/wages are flexible! Flexible wages/prices = Vertical LRAS

Shifting only SRAS Curve Shifts occur with a change in: Expected Price Level Input Prices Labor Capital Natural resources Technology Gov’t Incentives Shift SRAS but NOT LRAS Changes in the other 5 variables shifts BOTH curves (LRAS & SRAS)

Expected Price Level & Input Prices Shifting only SRAS example Expected Price Level & Input Prices Increase in either => shifts SRAS curve to left Decrease in either => shifts SRAS curve to right Recessionary Gap Expected price level falls SRAS shifts right Finish at long run equilibrium SRAS2 Should title be, “Why the short-run aggregate supply…” P2 --------------- E2

Conclusion AS/AD model will always “self-regulate” to a long run equilibrium as sticky prices/wages eventually become flexible If the Gov’t does not attempt to “fix” recessionary/inflationary gaps => SRAS will shift to reach full potential Recessionary Gap => expected price level ↓ => SRAS ↑ Inflationary Gap => expected price level ↑ => SRAS ↓ Recessionary Gap Inflationary Gap

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