1. Modelling Real GDP and the Price Level in the Short Run
Chapter 8
Modelling Real GDP and the Price Level in the Short Run

2. Copyright © 2005 Pearson Education Canada Inc.
Learning Objectives
8.1 Explain the concept of the short-run aggregate supply curve.
8.2 Understand what factors cause shifts in the short-run and long-run aggregate supply curves.
8.3 Evaluate the effects of aggregate demand and supply shocks on the equilibrium real output in the short run.
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3. Copyright © 2005 Pearson Education Canada Inc.
Learning Objectives
8.4 Explain the long-run adjustment process.
8.5 Explain how an open economy affects aggregate demand and aggregate supply.
8.6 Explain short-run inflation and economic growth in the economy.
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4. The Short-Run Aggregate Supply Curve
The relationship between aggregate supply and the price level in the short run.
Normally positively sloped.
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5. The Short-Run Aggregate Supply Curve
At a higher price
level firms make
more profits and
desire more output.
120
SRAS
Price Level
100
100
200
300
400
500
600
700
800
900
Real GDP per Year
($ billions)
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6. Shifts in the Aggregate Supply Curves
LRAS1
LRAS2
SRAS1
SRAS2
Any change that shifts LRAS will also shift SRAS
Price Level
1000
1200
1400
Real GDP per Year
($ billions)
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7. Shifts in the Aggregate Supply Curves
LRAS1
SRAS2
A temporary increase
in an input price
will shift only the
SRAS curve.
SRAS1
Price Level
1000
1200
1400
Real GDP per Year
($ billions)
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8. Shifts in the Aggregate Supply Curves
Changes That Cause an
Increase in Aggregate Supply
Discoveries of new raw materials
Increased competition
A reduction in international trade barriers
Fewer regulatory impediments to business
An increase in labour supplied
Increased training and education
A decrease in marginal tax rates
A reduction in input prices (SRAS only)
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9. Shifts in the Aggregate Supply Curves
Changes That Cause a
Decrease in Aggregate Supply
Depletion of raw materials
Decreased competition
An increase in international trade barriers
More regulatory impediments to business
A decrease in labour supplied
Decreased training and education
An increase in marginal tax rates
An increase in input prices (SRAS only)
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10. Copyright © 2005 Pearson Education Canada Inc.
Equilibrium
LRAS
120
SRAS AD
At price level
100 AD > AS and
the price level
increases.
Price Level
100
1000
1200
1400
Real GDP per Year
($ billions)
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11. Copyright © 2005 Pearson Education Canada Inc.
Equilibrium
LRAS
SRAS AD
140
At price level
140 AS > AD and
the price level
falls.
Price Level
120
1000
1200
1400
Real GDP per Year
($ billions)
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12. Copyright © 2005 Pearson Education Canada Inc.
Equilibrium
LRAS
SRAS AD
At price level
120 AD = AS.
Price Level
120
1000
1200
1400
Real GDP per Year
($ billions)
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13. Copyright © 2005 Pearson Education Canada Inc.
Equilibrium
Aggregate Demand Shock
Any shock that causes the aggregate demand curve to shift inward or outward.
Aggregate Supply Shock
Any shock that causes the aggregate supply curve to shift inward or outward.
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14. Copyright © 2005 Pearson Education Canada Inc.
Equilibrium
1200
LRAS
120 E1
SRAS
AD1
AD2
Price Level
Recessionary
Gap
1180
115 E2
Real GDP per Year
($ billions)
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15. Equilibrium LRAS SRAS Inflationary
AD2
AD1
Inflationary
Gap created by an increase in Aggregate Demand
1220
125 E2
Price Level
120 E1
1200
Real GDP per Year
($ billions)
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16. The Long-Run Adjustment Process
Inflationary and Recessionary gaps will not persist over time.
With an inflationary gap, excess demand for resources causes the prices of those resources to increase.
This causes the SRAS curve to shift to the left.
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17. The Long-Run Adjustment Process
125 E3
Excess demand for inputs shifts SRAS left E2
LRAS
SRAS
Price Level
120 E1
AD1
1200
1220
Real GDP per Year
($ billions)
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18. Aggregate Demand and Supply in an Open Economy
A stronger dollar increases Aggregate Supply because it reduces the cost of imported inputs.
A stronger dollar reduces Aggregate Demand because it makes exports more expensive, and imports less expensive.
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19. Aggregate Demand and Supply in an Open Economy
GDP1
Increase in the value of the dollar reduces the cost of imported inputs
SRAS1 AD
SRAS2
SRAS increases
Price Level E2 P2
GDP2
With AD constant, price level falls, GDP and employment increase
Real GDP per Year
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20. Aggregate Demand and Supply in an Open Economy
GDP1
Increase in the value of the dollar makes net exports fall
SRAS1
AD1
AD2
AD decreases
Price Level E2 P2
GDP2
With SRAS constant, prices, GDP, and employment decrease
Real GDP per Year
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21. Inflation and Growth in the Economy
Explaining Inflation: Demand-Pull or Cost- Push?
Demand-pull inflation
Inflation caused by increases in aggregate demand not matched by increases in aggregate supply.
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22. Inflation and Growth in the Economy
Cost-push inflation
Inflation caused by a continually decreasing short-run aggregate supply curve.
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23. Inflation and Growth in the Economy
1.8
LRAS
133 E1
SRAS
ADWorld War I
ADprewar
176 E2
2.3
Price Level
Real GDP per Year
($ billions)
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24. Inflation and Growth in the Economy
LRAS1
LRAS2
200
SRAS1
SRAS2
AD1
AD2
150
Price Level E1 E2
With economic growth,
LRAS1 and SRAS1
shift outward with
no inflation
100 50
700
800
Real GDP per Year
( $billions)
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