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PSU ECON 104 - What causes shifts in the Aggregate demand

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Econ 104 1st Edition Lecture 22Outline of Last Lecture I. Wealth Effect II. Interest Rate EffectIII. NX effect IV. LRASV. SRASOutline of Current Lecture II. Changes in SRASIII. Changes in LRASIV. Shifts Current LectureI. SRAS a. Short run aggregate supply b. SRAS shows the relationship in the Short Run between the price level and the quantity of real GDP supplied by firms c. When prices rise in the SR, firms produce more output because input prices are sticky or fixed II. Why are input prices sticky or fixed?a. It is difficult to predict future inflation when negotiating wages and prices of inputs i. Wages and prices of inputs are often set by contracts for one year or moreii. Menu costs1. The costs of firms of changing prices2. EXAMPLE: you own a coffee shop a. Suppose AD is increasing in US economy i. This increases the price of lattes, mochas, espressos, etc. b. Input costs are very slow to adjust These notes represent a detailed interpretation of the professor’s lecture. GradeBuddy is best used as a supplement to your own notes, not as a substitute.i. Profits and revenues increaseii. You have an incentive to increase outputiii. Profits = revenues – costsb. A rising price level leads to a larger quantity of goods and services supplied in theshort run III. Shifts in SRASa. An unexpected change in the price of an important natural resourcesi. For example: an increase in the price of oil ( supply shock) leads to an increase in the costs of production and there will be less produced at every priceb. Increase in the labor force and the capital stock (SRAS shift right)i. Firms can supply more at every pricec. Technological Change i. Increase productivity (SRAS shifts right)d. An increase in the expected future price level (SRAS shifts left) i. Workers will ask for a higher wage and firms will increase output pricese. Workers and firms adjust to errors in past expectations about the price level i. If prices are higher than expected, SRAS shifts leftii. If prices are lower than expected, SRAS shifts right IV. Example 1 of a SRAS shift a. An increase in AD and the automatic adjustment of prices and real output i. As AD shortage output starts to rise, prices will go up. Short run equilibrium will change. b. Short run adjustments: i. An increase in G or decrease iin r 1. Ad shifts right and there is an AD shortageii. Firms step up production to try and meet the increase in AD (expansion)1. Output prices (shortage) relative to input prices. Change in profits is greater than 0 iii. As output and prices increase, the economy moves to where the AD = SRASc. From SR to LRi. Workers and firms will adjust to the price level being higher than expected 1. Workers will ask for higher wages; firms will increase their prices 2. As a result, SRAS shifts left until Y = Y bar at the new equilibrium: AD = SRAS = LRAS V. Example 2 of a SRAS shift a. A decrease in AD and the automatic adjustment of prices and output i. A policy intervention 1. Decrease AD:a. Surplus b. Prices fallc. Output falls 2. SR equilibrium a. Workers accept lower wages b. Firms lower output prices ii. Short Run Adjustment 1. A decrease in G or an increase in R a. AD shifts left…surplus 2. Firms cut production and lay off workers (recession)a. Inventories build up and firms are forced to cut their prices. Output prices fall (surplus) relative to input prices (sticky/fixed) i. Change in profits is negative3. As output and prices fall, the economy moves from to where AD = SRASiii. From SR to LR1. Workers and firms will adjust to the price level being lower than expecteda. Workers will be willing to accept lower wages; firms will accept lower prices b. As a result, SRAS shifts right until Y = Y bar at the new LR equilibrium where: AD = SRAS =


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PSU ECON 104 - What causes shifts in the Aggregate demand

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