In the short run, the quantity of output that firms supply can deviate from the natural level of output if the actual price level in the economy deviates from the expected price level. Several theories explain how this might happen. For example, the sticky-price theory asserts that the output prices of some goods and services adjust slowly to changes in the price level. Suppose firms announce the prices for their products in advance, based on an expected price level of 100 for the coming year. Many of the firms sell their goods through catalogs and face high costs of reprinting if they change prices. The actual price level turns out to be 90. Faced with high menu costs, the firms that rely on catalog sales choose not to adjust their prices. Sales from catalogs will v , and firms that rely on catalogs will respond by v the quantity of output they supply. If enough firms face high costs of adjusting prices, the unexpected decrease in the price level causes the quantity of output supplied to v the natural level of output in the short run. Suppose the economy's short-run aggregate supply (AS) curve is given by the following equation: Quantity of Output Supplied = Natural Level of Output + ax (Price LevelActual - Price Levelgpected)
In the short run, the quantity of output that firms supply can deviate from the natural level of output if the actual price level in the economy deviates from the expected price level. Several theories explain how this might happen. For example, the sticky-price theory asserts that the output prices of some goods and services adjust slowly to changes in the price level. Suppose firms announce the prices for their products in advance, based on an expected price level of 100 for the coming year. Many of the firms sell their goods through catalogs and face high costs of reprinting if they change prices. The actual price level turns out to be 90. Faced with high menu costs, the firms that rely on catalog sales choose not to adjust their prices. Sales from catalogs will v , and firms that rely on catalogs will respond by v the quantity of output they supply. If enough firms face high costs of adjusting prices, the unexpected decrease in the price level causes the quantity of output supplied to v the natural level of output in the short run. Suppose the economy's short-run aggregate supply (AS) curve is given by the following equation: Quantity of Output Supplied = Natural Level of Output + ax (Price LevelActual - Price Levelgpected)
Chapter1: Making Economics Decisions
Section: Chapter Questions
Problem 1QTC
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Transcribed Image Text:6. Why the aggregate supply curve slopes upward in the short run
In the short run, the quantity of output that firms supply can deviate from the natural level of output if the actual price level in the economy deviates
from the expected price level. Several theories explain how this might happen.
For example, the sticky-price theory asserts that the output prices of some goods and services adjust slowly to changes in the price level. Suppose
firms announce the prices for their products in advance, based on an expected price level of 100 for the coming year. Many of the firms sell their
goods through catalogs and face high costs of reprinting if they change prices. The actual price level turns out to be 90. Faced with high menu costs,
the firms that rely on catalog sales choose not to adjust their prices. Sales from catalogs will
, and firms that rely on catalogs
v
will respond by
v the quantity of output they supply. If enough firms face high costs of adjusting prices, the unexpected decrease in the
price level causes the quantity of output supplied to
v the natural level of output in the short run.
Suppose the economy's short-run aggregate supply (AS) curve is given by the following equation:
Quantity of Output Supplied = Natural Level of Output + a x (Price LevelActual- Price LevelExpected)
The Greek letter a represents a number that determines how much output responds to unexpected changes in the price level. In this case, assume
that a = $2 billion. That is, when the actual price level exceeds the expected price level by 1, the quantity of output supplied will exceed the natural
level of output by $2 billion.
Suppose the natural level of output is $60 billion of real GDP and that people expect a price level of 100.
On the following graph, use the purple line (diamond symbol) to plot this economy's long-run aggregate supply (LRAS) curve. Then use the orange
line segments (square symbol) to plot the economy's short-run aggregate supply (AS) curve at each of the following price levels: 90, 95, 100, 105,
and 110.
125
120
AS
115
110
105
LRAS
100
95
06
90
85
80
75
10
20
30
40
50
60
70
80
90
100
OUTPUT (Billions of dollars)
The short-run quantity of output supplied by firms will rise above the natural level of output when the actual price level
v the price
level that people expected.
PRICE LEVEL
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