Econ Ch 13 The Simple Keynesian Aggregate Supply Curve at any given moment the economy has a clearly defined capacity or maximum output Difference btwn planned aggregate expenditure and aggregate output at full capacity is sometimes referred to as an inflationary gap Sustained inflation is inflation over some fairly long period of time Demand pull inflation is inflation initiated by an increase in aggregate demand Cost push or supply side inflation is caused by an increase in costs Stagflation occurs when output is falling during inflation The aggregate demand and aggregate supply equilibrium may occur at a very flat portion of AS curve when there exists considerable excess capacity and high unemployment in the economy The aggregate demand and aggregate supply equilibrium may occur at a very steep portion of AS curve when the economy is operating at or near full employment and output level is above full capacity When the economy has excess capacity input prices are slow to adjust whereas output adjusts quickly to increases in aggregate demand as the economy approaches full capacity prices increase at a faster rate than does output The aggregate supply curve is sometimes called the price output response curve Most economists accept that it is positively sloped at least in the short run Rise in immigration enlarges the labor force and shifts AS rightward Long run aggregate supply curve is vertical because all prices input and output change at the same rate in the long run Since wages and other costs are assumed to fully adjust to prices in the long run the long run AS curve is vertical The economy s potential output or potential GDP Yo represents the level of aggregate output that can be sustained in the long run without inflation When economy is operating well below capacity expansionary macroeconomic policy will result in a small price increase relative to the output increase If the economy is operating on the vertical part of the AS curve and the Fed pursues a policy of stabilizing interest rates in the face of expansionary fiscal policy the result will most likely be sustained inflation As the economy expands the Fed uses open market operations to raise the interest rate gradually to try to prevent the economy from expanding too quickly When suffering stagflation must decrease aggregate demand by raising the interest rate However will further increase unemployment A cost shock or supply shock is a change in costs that shifts the AS curve AS shifts to the right due to things such as lower costs input wage economic growth more capital more labor technological change public policy supply side policies tax cuts deregulation good weather AS shifts to the left due to things such as higher costs stagnation capital deterioration public policy waste and inefficiency over regulation bad weather natural disasters destruction from wars Equilibrium price level is the point at which the AD and AS curves intersect When AS is vertical in the long run neither monetary policy nor fiscal policy has any effect on aggregate output If the Fed tries to prevent crowding out it will increase the money supply and shift AD to the right However might result in hyperinflation