The Long Run Aggregate Supply Curve The Long run AS curve represents the economy at its full employment/natural rate of unemployment level. It is the level of output that an economy can produce if all of its resources are fully employed.

The Long-Run Aggregate Supply Curve In the long-run, an economy’s production of goods and services depends on its supplies of labor, capital, and natural resources and on the available technology used to turn these factors of production into goods and services. The price level does not affect these variables in the long run.

The Long-Run Aggregate- Supply Curve... Price Level Long-run aggregate supply P1 1. A change in the price level… 2. …does not affect the quantity of goods and services supplied in the long run. P2 Natural rate of output Quantity of Output

Why the Long-Run Aggregate Supply Curve Might Shift Shifts arising from Labor Shifts arising from Capital Shifts arising from Natural Resources Shifts arising from Technological Knowledge

Long-Run Growth Price Level LRAS1980 1. In the long-run, technological progress shifts long-run aggregate supply... LRAS2000 LRAS1990 Y1990 Y2000 2. …leading to growth in output... Y1980 Quantity of Output

SHORT RUN AGGREGATE SUPPLY Short-run aggregate supply measures current production within our economy It is determined by current price levels and two factors The cost of production Input prices Productivity levels (technology) Legal-institutional factors (taxes and government regulations) Changes in the expected price level

SHORT RUN AGGREGATE SUPPLY There are three reasons why the Short run Aggregate Supply curve is upward sloping. Sticky wages - as prices rise wages may be slow to follow, allowing business owners to profit from higher prices. Sticky prices- all prices do not rise simultaneously. A business that is slow to raise their prices may sell more in the short run. Misperceptions of price increases – a business owner may assume incorrectly that the increase in price level is the result of an increase in demand for THEIR product and therefore increase production.

SHORT-RUN AGGREGATE SUPPLY A higher price level increases profits and output moving the economy from a1 to a2 AS1 P2 a2 Price Level P1 a1 o Q1 Q2 Real domestic output

SHORT-RUN AGGREGATE SUPPLY A lower price level decreases profits and output moving the economy from a1 to a3 AS1 P2 a2 Price Level P1 a1 P3 a3 o Q3 Q1 Q2 Real domestic output

Why the Short-run Aggregate Supply Curve Might Shift Shifts arising from a change in Labor costs. Shifts arising from a change in Capital costs. Shifts arising from a change in Natural Resource costs. Shifts arising from a change in Technology. Shifts arising from a change in the Expected Price Level.

A Decrease in Aggregate Supply... 1. An adverse shift in the short-run aggregate-supply curve… AS2 Price Level Long-run aggregate supply Short-run aggregate supply, AS1 2. …causes output to fall… B Y2 3. …and the price level to rise. P2 A P1 Aggregate demand Y1 Quantity of Output

An Increase in Aggregate Supply Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. An Increase in Aggregate Supply Long-run aggregate supply Price Level Short-run aggregate supply, AS1 AS2 P1 A P2 B Aggregate demand, AD1 Y1 Y2 Quantity of Output

Expected Inflation and Actual Inflation The short-run trade-off between unemployment and inflation exists only because of misperceptions about the actual rate of inflation. In other words actual inflation may be different from expected inflation. If actual inflation is higher than what workers expected there will be an increase in output and a decrease in unemployment.

Price Level o Real domestic output Expected versus Actual Inflation – higher than expected price levels increase output ASLR AS1 P2 a2 a1 Price Level P1 o Q1 Q2 Real domestic output

Shifts Arising from a Change in Expected Price Level When people expect an increase in price levels they tend to set wages high. This shifts the short-run aggregate supply curve to the left. When people expect a decrease in price levels the tend to set wages low. This shifts the short-run aggregate supply curve to the right.

Price Level o Real domestic output AGGREGATE SUPPLY IN THE SHORT AND LONG-RUN A higher expected price level results in higher nominal wages and thus shifts the short-run aggregate supply to the left. The result is higher prices, but a return to the original level of output. AS2 b1 AS1 P2 a2 a1 Price Level P1 o Q1 Q2 Real domestic output

Price Level o Real domestic output AGGREGATE SUPPLY IN THE SHORT AND LONG-RUN A lower expected price level reduces nominal wages and shifts the short-run aggregate supply to the right. This results in lower prices, but a return to the original level of output. ASLR AS2 b1 AS1 P2 a2 AS3 a1 Price Level P1 P3 a3 c1 o Q3 Q1 Q2 Real domestic output

AGGREGATE SUPPLY IN THE SHORT AND LONG-RUN Short Run - Period in which nominal wages (and other input prices) remain fixed as the price level increases or decreases Long Run - Period in which nominal wages are fully responsive to previous changes in the price level