Econ 104 Final Exam Study Guide I Long Run Short Run Aggregate Supply Curves a Long Run Identifies output at potential full employment i ii Shifters 1 Change in resource bases change in labor force baby boom change in population 2 Change in size of capital stock 3 Technical change innovation iii Left Shift Example Hurricane Sandy 1 Tremendous damage along East Coast 2 Loss of capital businesses transportation systems b SRAS i Upward sloping ii As the price level increases the quantity of goods and services firms are willing to supply increases iii Example Coffee Shop Owner 1 One of many firms producing output c Why is SRAS upward sloping Input prices e g wages are sticky e g you own a coffee shop i ii Suppose AD increases in the US economy 1 Output prices are flexible which increase prices of lattes mochas etc Input costs are slow to adjust 2 a Profits and revenues increase i Profits revenues costs b You have an incentive to increase output 3 When price level increases in short run from GDP deflator 100 to 110 firms produce more output because input prices are sticky iii Menu Costs 1 As demand and price level increase some firms may not increase their prices due to menu costs a Menu costs the costs to forms of changing prices 2 These firms respond to the increase in demand relatively lower price by increasing quantity supplied 3 Conclusion A rising price level leads to a larger quantity of goods and services supplied i An unexpected change in the price of an important natural 1 Example An increase in the price of oil supply shock 2 3 Increase of oil price implies SRAS shifts leftward Immediate reaction to shock is to cut production d Shifts in SRAS resource 4 Output decreases unemployment increases and price level eventually adjusts slow 5 Prior to Great Recession 2003 2008 a Surging demand for oil by developing economies mainly China and India b Oil suppliers were weak stagnant ii Increase in the labor force the capital stock 1 Right shift more output produced at every price level iii Technological change Increase in productivity 1 2 Right shift costs of producing output decrease iv An increase in the expected future price level 1 Left shift workers firms increase wages and prices v Workers and firms adjustment to errors in past expectations about the price level 1 Left shift workers firms increase wages and prices vi The expected price of an important natural resource increases 1 Left shift costs of producing output rise e Impact of Oil Price Shock i Negative price shock ii Negative because it can throw us into recession iii Long run equilibrium is restored due to flexible wages and prices f Impact of Positive Supply Shock Internet i LRAS shifts rightward ii Firms able to produce more output iii SRAS shifts rightward because of an increase in productivity which lowers cost iv Price levels fall output rises but full employment unchanged g Negative Demand Shock Decrease in Investment Expenditures h Great Recession i Rightward shift in SRAS ii Leftward shift in AD iii Workers willing to accept lower wages iv Firms accept lower prices for output i Small increase in price level ii Dramatic decrease in output iii Leftward shift in SRAS iv Leftward shift in AD decrease C and I i New Economy i Economic growth resulting from technological advances that make businesses and workers more productive ii Example Technological innovation of 1990s Increase productivity and increase capital stock 1 2 Strong AD a Increase wealth Increase consumer confidence Increase investment b c d Small increase in price level iii Conclusions 1 Without policy intervention stabilization policy the automatic adjustment mechanism kicks in a Assuming P W are flexible