1. Extending the Analysis of Aggregate Supply
Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
McGraw-Hill/Irwin

2. From Short Run to Long Run
Input prices inflexible
Upsloping aggregate supply
Long run
Input prices fully flexible
Vertical aggregate supply
The transition?
LO1
35-2

3. From Short Run to Long Run
Production above potential output:
High demand for inputs
Input prices rise
Short run aggregate supply shifts left
Return to potential output
Production below potential output
Graphical examples…
LO1
35-3

4. From Short Run to Long Run
Aggregate Supply
Long-Run
Aggregate Supply
AS1
AS2
ASLR
AS1 a2 b1 a2
AS3 P2 P2
Price Level a1
Price Level a1 P1 P1 a3 a3 P3 P3 c1 Q3 Qf Q2 Qf
Real Domestic Output
Real Domestic Output
LO1
35-4

5. From Short Run to Long Run
Long Run Equilibrium
ASLR
AS1
Price Level P1 a
AD1 Qf
Real Domestic Output
LO1
35-5

6. Demand-Pull Inflation
Extended AD-AS Model
Demand-Pull Inflation
AS2
ASLR
AS1 P3 c P2 b
Price Level P1 a
AD2
AD1 Qf Q2
Real Domestic Output
LO2
35-6

7. Extended AD-AS Model Cost-Push Inflation P3 c Price Level P2 b a P1 Q2
ASLR
AS1 P3 c P2 b
Price Level P1 a
AD2
AD1 Q2 Qf
Real Domestic Output
LO2
35-7

8. Extended AD-AS Model Recession P1 a P2 b Price Level P3 c Q1 Qf
ASLR
AS1
AS2 P1 a P2 b
Price Level P3 c
AD1
AD2 Q1 Qf
Real Domestic Output
LO2
35-8

9. Explaining ongoing inflation
Extended AD-AS Model
Explaining ongoing inflation
Ongoing economic growth shifts aggregate supply
Ongoing increases in money supply shift aggregate demand
Small positive rate of inflation
LO2
35-9

10. Economic Growth, Ongoing Inflation
Productions Possibilities
Long Run Aggregate Supply
Capital Goods
Price Level
Consumer Goods
Real GDP
Increase in production possibilities
Increase in long-run aggregate supply
LO2
35-10

11. Inflation and Unemployment
Low inflation and unemployment
Fed’s major goals
Compatible or conflicting?
Short-run tradeoff
Supply shocks cause both rates to rise
No long-run tradeoff
LO3
35-11

12. 1960s economists believed in stable, predictable tradeoff
The Phillips Curve
1960s economists believed in stable, predictable tradeoff
Phillips curve shifts over time
Adverse supply shocks 1970s
OPEC oil price shock
Stagflation
Stagflation’s demise 1980s
LO3
35-12

13. No long-run tradeoff between inflation and unemployment
The Phillips Curve
No long-run tradeoff between inflation and unemployment
Short-run Phillips curve
Role of expected inflation
Long-run vertical Phillips curve
Disinflation
LO4
35-13

14. The Phillips Curve Annual rate of inflation (percent)14 13 12 11 10 9 8 7 6 5 4 3 2 1
Annual rate of inflation (percent)
Unemployment rate (percent)
LO4
35-14

15. Taxes and Aggregate Supply
Supply-side economics
Tax incentives to work
Tax incentives to save and invest
The Laffer curve
100 n
Laffer Curve
Tax Rate (Percent) m m
Maximum
Tax Revenue l
Tax Revenue (Dollars)
LO5
35-15

16. Taxes and Aggregate Supply
Criticisms of the Laffer curve
Taxes, incentives, and time
Inflation and higher real interest rates
Position on the curve
Rebuttal and evaluation
LO5
35-16