Aggregate Supply Changes and the Economy zThis chapter -- looks at the effects of changes in Aggregate Supply, or shifts in the AS curve, on Y* and P*.

Short-Run Aggregate Supply (AS) zShort-Run Aggregate Supply (AS) -- the sum of all the newly produced US final goods and services that firms wish to produce (real GDP supplied), given inflexible input prices (such as the nominal wage rate and the price of energy).

Short-Run Aggregate Supply (AS) -- Causes zPrice Level (P) P   AS  zPrice of Energy (P E ) P E   AS  zThe Nominal Wage Rate (W) W   AS 

Short-Run Aggregate Supply -- More Causes zLabor Productivity (PROD) PROD   AS  zCapital Stock (K) -- all the existing plant and equipment used by firms to produce goods and services. K   AS 

Formalizing the AS Curve zUpward sloping when graphed against P. zChanges in a cause other than P -- described as shifting the AS curve. zChanges in variables that enhance production shift the AS curve rightward. zChanges in variables that hinder production shift the AS curve leftward.

Applications -- Supply Effects on the Economy z

Example 1 -- A Supply Shock zExample 1 -- The price of energy (P E ) increases (energy crisis in US, 1973 and 1979). zP E  hinders production, reduces Aggregate Supply. zTherefore the AS curve shifts leftward. zAs a result, Y* , P*  (Yuck!!).

Example 2 -- Productivity: The “Magic” Variable zExample 2 -- Labor productivity (PROD) increases (late 1990s, 2000 in US). zPROD  enhances production, increases Aggregate Supply. zTherefore the AS curve shifts leftward. zAs a result, Y* , P*  (Wow!!).

Example 3 -- The Wage-Price Spiral zExample 3 -- Increases in (G - T) (increase in government purchases, or decrease in taxes) moves Y* beyond Y F and accelerates inflation. Labor wants their wages to keep pace with inflation, sp they get larger than normal wage increases (W  ).

Describing The Wage-Price Spiral -- AD-AS Model zIncrease in (G - T) shifts AD curve rightward, Y*  beyond Y F, P* . zThe rise in W is described by a shift of the AS curve leftward. zAs a result Y* returns to its previous level, P*  even more (Draw the diagram and see for yourself!!)

The Long-Run Aggregate Supply (LAS) Curve zVertical when plotted versus the price level (P). zVertical at the full sustainable level of real GDP (Y F )

Shifting the LAS Curve zCurve shifts either rightward (increase in LAS) or leftward (decrease in LAS) zVariables that shift the curve rightward, therefore, increase Y F. zVariables that shift the curve leftward, therefore, decrease Y F.

Shift Variables – LAS Curve (factors that change Y F ) zLabor Productivity (PROD) PROD   LAS  zCapital Stock (K) -- all the existing plant and equipment used by firms to produce goods and services. K   LAS 

More Shift Variables – LAS Curve (factors changing Y F ) zSize of Labor Force Labor Force   LAS  zAttitudes Toward Work. Work   LAS  zTransfer Payments (TP) TP   LAS 

Application #1 – What Makes Y F Grow in the US? zSteady Growth in the Following Variables: yLabor Force yCapital Stock Accumulation yLabor Productivity zAverage Growth of Y F in US: 2.5% per year zNot the same for all countries in the world.

Application #2 – Effects of a Productivity Boom zSuppose that increased technology (e.g. computerization) makes labor more productive. zProductivity growth increases, shifts LAS curve rightward more than usual.

Application #2 Continued -- Effects on Y F zTherefore Y F in the US grows at more than 2.5%. zThis implies that actual real GDP (Y*) can enjoy higher growth without accelerating inflation. zVery nice!!