1. Macroeconomic Theory Continued
Aggregate Supply
Macroeconomic Theory Continued

2. Aggregate Supply Curve
Aggregate-supply curve (AS)- how supply of goods & services for the entire economy changes with inflation
quantity of goods/services all firms produce at each price level
Short run curve (SRAS) is upward sloping
Long Run curve (LRAS) is vertical

3. Determinants of Real GDP
In long run, economy’s output depends on quantity of:
Labor
Capital,
Natural resources
Technology
In long run, Price level does not affect these variables
Price Level is related only to
Quantity of Money

4. Natural Rate of Output potential output or full-employment output
Definition: Level of Real GDP economy achieves in long run at full-employment
LRAS is vertical at level of “natural rate of output”
This level of production is also called:
potential output or full-employment output

5. Long-Run AS Curve Real Output Does NOT Change! Inflation Doubles:
Price
Inflation Doubles:
Real Output
Does NOT
Change!
Level
LRAS P
A change in
price level P2
Does NOT affect
Qty of goods/services
supplied
Natural rate
Real GDP
of output
Full Employment
Output

6. Why is the Short Run AS Curve upward sloping?
2 Primary Theories:
Sticky-Wage Theory
Sticky-Price Theory
(you can ignore 3rd theory in Textbook— misperceptions theory)
The order of discussion in Mankiw has been changed. The “misperceptions theory” must be moved to the bottom of the list. (This may affect the entire order of presentation following this slide.)

7. Sticky-Wage Theory
Nominal wages are slow to adjust to changing economic conditions
Wages are “sticky” in short run
Example: Price level falls => Nominal wages do not adjust immediately
Production is now less profitable because wages are artificially high
So firms reduce quantity of goods & services supplied

8. Sticky Wages in Action Business sign 2-year contract
to pay Workers $20/ hour
Price Level
Suddenly rises
Wages are cheap
in “real dollars”
Firm will increase
supply

9. Sticky Price Theory
Prices of some goods & services adjust sluggishly in response to changing economic conditions
An unexpected fall in price level leaves some firms with higher-than-desired prices
This depresses sales, which induces firms to supply less

10. Conclusion
Output deviates only in short run when actual price level deviates from expected price level
In long run, wages & prices are not “sticky” and do not affect output (price level has no effect)
Prices/wages become flexible!

11. Worksheet
Shapes of AS Curves P1 E1 Y1