1. Short Run Aggregate Supply
Shifting only SRAS

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

3. 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!

4. 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

5. 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)

6. 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…” P E2

7. 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

8. Worksheet