1. Extending the Analysis of16
C H A P T E R
Extending the Analysis of
Aggregate Supply

2. SHORT-RUN AND LONG-RUN
AGGREGATE SUPPLY
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

3. 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 Qf Q2
Real domestic output

4. 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 Qf Q2
Real domestic output

5. LONG-RUN AGGREGATE SUPPLY
A higher price level results in higher nominal wages and thus shifts the short-run aggregate supply to the left .
ASLR
AS2 b1
AS1 P2 a2 a1
Price Level P1 o Qf
Real domestic output

6. LONG-RUN AGGREGATE SUPPLY
A lower price level results reduces nominal wages and shifts the short-run aggregate supply to the right .
ASLR
AS2 b1
AS1 P2 a2
AS3 a1
Price Level P1 P3 a3 c1 o Qf
Real domestic output

7. EQUILIBRIUM IN THE EXTENDED AD-AS MODEL
ASLR
AS1
Price Level P1 a
AD1 o Qf
Real domestic output

8. DEMAND-PULL INFLATION
ASLR
AS2
AS1 c P3
Price Level P2 b P1 a
AD2
AD1 o Qf Q1
Real domestic output

9. COST-PUSH INFLATION Occurs when short-run AS shifts left Price Level o
ASLR
AS2
AS1
Price Level P2 b P1 a
AD1 o Q2 Qf
Real domestic output

10. COST-PUSH INFLATION Even higher price levels
Government response with increased AD
ASLR
AS2
AS1
Even
higher
price
levels c P3
Price Level P2 b P1 a
AD2
AD1 o Q2 Qf
Real domestic output

11. COST-PUSH INFLATION If government allows a recession to occur
ASLR
AS2
AS1
Price Level P2 b P1 a
AD1 o Q2 Qf
Real domestic output

12. COST-PUSH INFLATION If government allows a recession to occur Nominal
ASLR
AS2
AS1
Nominal
wages fall &
AS returns
to its original
location
Price Level P2 b P1 a
AD1 o Q2 Qf
Real domestic output

13. THE INFLATION-UNEMPLOYMENT
RELATIONSHIP
Normally, there is a short-run trade-off between the rate of inflation and the the rate of unemployment.
Aggregate supply shocks can cause both higher rates of inflation and higher rates of unemployment.
There is no significant trade-off over long periods of time.

14. Price Level o Real domestic output
EFFECT OF CHANGES IN AGGREGATE DEMAND
ON REAL OUTPUT AND THE PRICE LEVEL
AD0 AS
Price Level P0 o Q0
Real domestic output

15. Price Level o Real domestic output
EFFECT OF CHANGES IN AGGREGATE DEMAND
ON REAL OUTPUT AND THE PRICE LEVEL
AD0
AD1 AS
Price Level P1 P0 o Q0 Q1
Real domestic output

16. Price Level o Real domestic output
EFFECT OF CHANGES IN AGGREGATE DEMAND
ON REAL OUTPUT AND THE PRICE LEVEL
AD0
AD1
AD2 AS
Price Level P2 P1 P0 o Q0 Q1 Q2
Real domestic output

17. Price Level o Real domestic output
EFFECT OF CHANGES IN AGGREGATE DEMAND
ON REAL OUTPUT AND THE PRICE LEVEL
AD0
AD1
AD2
AD3 AS P3
Price Level P2 P1 P0 o Q0 Q1 Q2 Q3
Real domestic output

18. Annual rate of inflation Unemployment rate (percent)
THE PHILLIPS CURVE CONCEPT 7 6 5 4 3 2 1
As inflation declines...
unemployment
increases
Annual rate of inflation
(percent)
Unemployment rate (percent)

19. GLOBAL PERSPECTIVE 1992 1997 2002 The Misery Index, Selected Nations
Canada
Italy 15 10 5
U.K.
France
U.S.
Germany
Japan
1992
1997
2002
Source: Bureau of Labor Statistics

20. Aggregate-Supply Shocks Stagflation’s Demise Short-Run Phillips Curve
THE LONG-RUN PHILLIPS CURVE
Aggregate-Supply Shocks
Stagflation’s Demise
Short-Run Phillips Curve
Long-Run Vertical Phillips Curve
Disinflation

21. Supply-Side Economics Taxes and Incentives to Work
TAXATION AND AGGREGATE SUPPLY
Supply-Side Economics
Taxes and Incentives to Work
Incentives to Save and Invest
Laffer Curve

22. THE LAFFER CURVE
100
Tax rate (percent) l
Tax revenue (dollars)

23. THE LAFFER CURVE
100
Tax rate (percent) m l
Tax revenue (dollars)

24. THE LAFFER CURVE
100 n
Tax rate (percent) m l
Tax revenue (dollars)

25. THE LAFFER CURVE Maximum Tax Revenue Tax rate (percent)
100 n
Tax rate (percent) m m
Maximum
Tax
Revenue l
Tax revenue (dollars)

26. Taxes, Incentives, and Time Inflation or Higher Interest Rates
Criticisms of the Laffer Curve
Taxes, Incentives, and Time
Inflation or Higher Interest Rates
Position on the Curve
Rebuttal and Evaluation

27. aggregate supply shocks long-run vertical Phillips curve disinflation
KEY TERMS
short run
long run
Phillips curve
stagflation
aggregate supply shocks
long-run vertical Phillips curve
disinflation
supply-side economics
Laffer curve
Copyright McGraw-Hill/Irwin, 2005
BACK
END

28. Up next...
Economic Growth
Chapter 17