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UVA ECON 2020 - 9-26-2012Handout

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Aggregate SupplyAggregate SupplyAggregate SupplyElias YannopoulosSeptember 26, 2012Elias Yannopoulos Aggregate SupplyAggregate SupplyThinking About SupplyResources (workers, capital, materials) ⇒ Firms ⇒ Output(goods, services)The firm cares about two groups of prices resource prices(wages, interest rates, input prices) and output pricesHow do firms respond when the price level increases?There are two possible responsesIncrease outputDo not change outputIf input and output prices increase together then there shouldbe no change in outputIf only output prices rise then firms should increase outputWhat happens to supply when the price level changes?Elias Yannopoulos Aggregate SupplyAggregate SupplySlope of Aggregate SupplyLong Run: Enough time for all prices to adjustShort Run: A time where some prices have not yet adjustedSticky prices - a concept that some prices cannot changequickly in response shocksIn this model, input prices are assumed to be stickier thanoutput pricesThis gives us two AS curves, one for the long run and one forthe short runThe Short Run Aggregate Supply (SRAS) curve - has apositive slope like other supply curvesThis is the curve for when input prices are assumed fixed butoutput prices flexibleThe Long Run Aggregate Supply (LRAS) curve - is the outputthat the economy can produce when all prices are flexibleElias Yannopoulos Aggregate SupplyAggregate SupplyShifts in Aggregate SupplyLRAS shifts when there is a change in long run potentialoutputWhat causes long run potential output to change?Hint: we spent an entire week of class talking about itResources, Technology, InstitutionsShifting LRAS also Shifts SRASWhat causes shifts in SRAS only then?Some supply shocks do not affect long run productivityTemporary supply shocks, Ex: weatherExpected future price levelsImport pricesElias Yannopoulos Aggregate SupplyAggregate SupplyEquilibriumLong Run Equilibrium vs Short Run EquilibriumLong Run Equilibrium has 3 important featuresLRAS = AD = SRASY = Y*u = u*Short run equilibrium, SRAS = ADElias Yannopoulos Aggregate SupplyAggregate SupplyShocks to EquilibriumExample: AD increaseShort run resultsP ↑ Y ↑ u ↓Long run resultsP ↑ Y=Y* u=u*Expected inflation exampleExpected inflation is self fulfillingElias Yannopoulos Aggregate


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UVA ECON 2020 - 9-26-2012Handout

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