Extending the Analysis of Aggregate Supply

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

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-

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

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

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

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

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

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-

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

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-

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
The Phillips Curve
LO3
35-

Alban William Phillips

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 (increase the purchasing power of the local currency that is shown in the reduction of the price index)
LO4
35-

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

Taxes and Aggregate Supply
Supply-side economics
Tax incentives to work
Tax incentives to save and invest
The Laffer curve
Tax Rate (Percent)
Tax Revenue (Dollars)
100
m
0
n
l
m
Laffer Curve
Maximum
Tax Revenue
LO5
35-