1. Economics 020
Lecture 12
6 October, 1997

2. Aggregate Demand and Aggregate Supply
AD-AS equilibrium

3. Aggregate Supply
The sum of the quantities of all the final goods produced in the economy is called the aggregate quantity of goods and services produced
It is measured by real GDP
Aggregate supply is the relationship between the quantity of real GDP supplied and the price level

4. Aggregate Supply We distinguish two time frames for aggregate supply:
Long-run aggregate supply
Short-run aggregate supply

5. Long-Run Aggregate Supply
Long-run aggregate supply is the relationship between the quantity of real GDP supplied and the price level when real GDP equals potential GDP
Potential GDP is real GDP when all the economy’s labor, capital, land, and entrepreneurial ability are fully employed

6. Long-Run Aggregate Supply
The long-run aggregate supply curve LAS, is vertical at potential GDP

7. Long-Run Aggregate Supply
A movement along the LAS curve, means that two sets of prices are changing:
the price level
the money wage rate

8. Long-Run Aggregate Supply
Because both the price level and the money wage rate change, the real wage rate remains constant.

9. Long-Run Aggregate Supply
The real wage rate remains at the level that achieves full employment of labor

10. Short-Run Aggregate Supply
Short-run aggregate supply is the relationship between the quantity of real GDP supplied and the price level when the money wage rate and all other influences on production plans remain constant
Fig shows short-run aggregate supply

11. Short-Run Aggregate Supply
The short-run aggregate supply (SAS) curve is upward-sloping
At a price level of 120, the quantity of real GDP supplied is $500 billion

12. Short-Run Aggregate Supply
At a price level of 130, the quantity of real GDP supplied is $600 billion, which equals potential GDP

13. Short-Run Aggregate Supply
At a price level of 140, the quantity of real GDP supplied is $700 billion, which exceeds potential GDP

14. Short-Run Aggregate Supply
The SAS curve slopes upward because, when the price level rises with a constant money wage rate, firms make a larger profit by producing a larger output

15. Movements Along LAS and SAS
A rise in both the price level and the money wage rate that maintains full employment brings a movement along the LAS curve

16. Movements Along LAS and SAS
A rise in both the price level at a constant money wage rate brings a change in employment and real GDP and a movement along the SAS curve

17. Changes in Aggregate Supply
Long-run aggregate supply changes when potential GDP changes.
And potential GDP changes for two basic reasons:
aggregate labor hours (at full employment) increases
labor productivity increases

18. Changes in Aggregate Supply
Labor productivity increases for three reasons:
growth of the capital stock
growth of human capital
technological change

19. Changes in Aggregate Supply
Short-run aggregate supply changes for all the reasons that long-run aggregate supply changes
In addition, short-run aggregate supply changes when the money wage rate changes

20. Changes in Aggregate Supply
When potential GDP increases, both LAS and SAS shift rightward

21. Changes in Aggregate Supply
When the money wage rate rises, the SAS curve shifts leftward but the LAS curve remains unchanged

22. Short-Run Equilibrium
Short-run equilibrium occurs when the quantity of real GDP demanded equals the quantity of real GDP supplied
Short-run equilibrium occurs at the point of intersection of the AD curve and the SAS curve

23. Short-Run Equilibrium
If the price level exceeds 130, the quantity of real GDP supplied exceeds the quantity of real GDP demanded

24. Short-Run Equilibrium
Because there is a surplus of goods and services, firms cut prices and decrease production

25. Short-Run Equilibrium
If the price level is below 130, the quantity of real GDP demanded exceeds the quantity of real GDP supplied

26. Short-Run Equilibrium
Because there is a shortage of goods and services, firms raise prices and increase production

27. Short-Run Equilibrium
If the price level equals 130, the quantity of real GDP demanded equals the quantity of real GDP supplied

28. Short-Run Equilibrium
Because there is neither a surplus nor a shortage of goods and services, firms keep prices production constant

29. Short-Run Equilibrium
When equilibrium real GDP is below potential GDP, there is a recessionary gap
Here, the recessionary gap is $100 billion

30. Short-Run Equilibrium
When equilibrium real GDP equals potential GDP, there is a full employment
Here, the full employment is at a real GDP of $600 billion

31. Short-Run Equilibrium
When equilibrium real GDP exceeds potential GDP, there is an inflationary gap
Here, the inflationary gap is $100 billion

33. Next Long-term growth, inflation, and cycles
Growth, inflation, and cycles in Canada