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Aggregate Supply Module 18
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Short-Run Aggregate Supply (SRAS)
Upward sloping, just as in market case But again for different reasons Profits = Price of Outputs – Price of Inputs Revenue generated by price increases outpaces increases in input costs (wages are “sticky”) So, in the short-run curve slopes upwards Reverse is also true
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Changes in SRAS Changes in commodity prices Changes in nominal wages
Oil; steel Decrease in commodity prices = increase in SRAS Changes in nominal wages Increase in nominal wages = decrease in SRAS Change in productivity Increases in productivity = increase in SRAS
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Figure Shifts of the Short-Run Aggregate Supply Curve Ray and Anderson: Krugman’s Macroeconomics for AP, First Edition Copyright © 2011 by Worth Publishers
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Long-Run Aggregate Supply (LRAS)
In the longer term, “sticky” input prices “catch up” to output prices Therefore, in the long run, price level should have no affect on aggregate supply So, aggregate supply would be a vertical line
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Long-Run Aggregate Supply
What is the significance of the output value (Y) at which the LRAS is vertical? The answer is the economy’s potential output YP This represents the level at which the economy would produce if all prices (including wages) were perfectly flexible
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Figure The Long-Run Aggregate Supply Curve Ray and Anderson: Krugman’s Macroeconomics for AP, First Edition Copyright © 2011 by Worth Publishers
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Figure Actual and Potential Output from 1989 to 2009 Ray and Anderson: Krugman’s Macroeconomics for AP, First Edition Copyright © 2011 by Worth Publishers
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Short Run v. Long Run At any given point in time, the economy is on the the short-run aggregate supply (SRAS) curve Since the long-run aggregate supply (LRAS) curve is a vertical line, the SRAS will intersect it at some point Events that shift the SRAS, will shift the point at which the SRAS and LRAS intersect
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Shifts in SRAS Changes in Commodity Prices Changes in Nominal Wages
Steel; Oil Decrease in commodity prices; SRAS shifts right Changes in Nominal Wages Decrease in nominal wages; SRAS shifts right Changes in Productivity Increase in commodity prices; SRAS shifts right
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Figure From the Short Run to the Long Run Ray and Anderson: Krugman’s Macroeconomics for AP, First Edition Copyright © 2011 by Worth Publishers
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Macroeconomic Equilibrium The AD-AS Model
Module 18
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Figure The AD–AS Model Ray and Anderson: Krugman’s Macroeconomics for AP, First Edition Copyright © 2011 by Worth Publishers
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Demand Shocks Expectations Wealth Stock of productive capital
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Figure Demand Shocks Ray and Anderson: Krugman’s Macroeconomics for AP, First Edition Copyright © 2011 by Worth Publishers
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Supply Shocks Commodity prices Nominal wages Productivity
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Figure Supply Shocks Ray and Anderson: Krugman’s Macroeconomics for AP, First Edition Copyright © 2011 by Worth Publishers
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Figure Long-Run Macroeconomic Equilibrium Ray and Anderson: Krugman’s Macroeconomics for AP, First Edition Copyright © 2011 by Worth Publishers
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Figure Short-Run Versus Long-Run Effects of a Negative Demand Shock Ray and Anderson: Krugman’s Macroeconomics for AP, First Edition Copyright © 2011 by Worth Publishers
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Figure Short-Run Versus Long-Run Effects of a Positive Demand Shock Ray and Anderson: Krugman’s Macroeconomics for AP, First Edition Copyright © 2011 by Worth Publishers
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Calculating the Gap To calculate the % value of a inflationary or recessionary gap: Output Gap = Actual Aggregate Output – Potential Output x 100 Potential Output
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In the long run… The value of all gaps will tend towards zero
In recessionary gaps, wages will fall and SRAS will increase In inflationary gaps, wages will rise and SRAS will decrease
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Example Short run equilibrium? Long run equilibrium? What kind of gap?
LRAS Short run equilibrium? Long run equilibrium? What kind of gap? If Y1 = 160 and YP= 200 what is the output gap? What will happen over time? Agg. Price Level AD SRAS E P1 Yes. AD=SRAS at Y1 No. Not equal to potential output Recessionary gap: Y1 < YP ( )/200 = -40/200 = -20% Wages will decline leading to an increase in SRAS. Output will increase to match potential output at a lower Aggregate Price Level. Y1 Real GDP
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