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Aggregate Supply: Introduction and Determinants

Aggregate supply curve

shows the relationship between the aggregate price level and the quantity of aggregate output supplied in the economy

nominal wage

the dollar amount of the wage paid.

sticky wages

nominal wages that are slow to fall even in the face of high unemployment and slow to rise even in the face of labor shortages

short-run aggregate supply curve

shows the relationship between the aggregate price level and the quantity of aggregate output supplied that exist in the short run, the time period when many production costs can be taken as fixed.

long-run aggregate supply curve

shows the relationship between the aggregate price level and the quantity of aggregate output supplied that would exist if all prices, including nominal wages, were fully flexible

potential output

the level of real GDP the economy would produce if all prices including nominal wages, were fully flexible

Determine the effect of short-run aggregate supply of each of the following events. Explain whether it represents a movement along the SRAS curve or a shift of the SRAS curve.
a. A rise in the consumer price index (CPI) leads producers to increase output.
b. a fall in the price of oil leads producers to increase output.
c. A rise in legally mandated retirement benefits paid to workers leads producers to reduce output.

a. This represents a movement along the SRAS curve because the CPI-like the GDP deflator -is a measure of the aggregate price level, the overall price level of final goods and services in the economy.
b. This represents a shift of the SRAS curve because oil is a commodity. The SRAS curve will shift to the right because production costs are now lower, leading to a higher quantity of aggregate output supplied at any given aggregate price level.
c. This represents a shift of the SRAS curve because it involves a change in nominal wages. An increase in legally mandated benefits to workers is equivalent to an increase in nominal wages. As a result, the SRAS curve will shift leftward because production costs are now higher, leading to a lower quantity of aggregate output supplied at any given aggregate price level.

Suppose the economy is initially at potential output and the quantity of aggregate output supplied increases. What information would you need to determine whether this was due to a movement along the SRAS curve or a shift of the LRAS curve.

You would need to know what happened to the aggregate price level. If the increase in the quantity of aggregate output supplied was due to a movement along the SRAS curve, the aggregate price level would have increased at the same time as the quantity of aggregate output supplied increased. If the increase in the quantity of aggregate output supplied was due to a rightward shift of the LRAS curve, the aggregate price level might not rise. Alternatively, you could make the determination by observing what happened to aggregate output in the long run. If it fell back to its initial level in the long run, then the temporary increase in aggregate output was due to a movement along the SRAS curve. If it stayed at the higher level in the long run, the increase in aggregate output was due to a rightward shift of the LRAS curve.

Which of the following will shift the short-run aggregate supply curve? A change in
a. profit per unit at any given price level
b. commodity prices
c. nominal wages
d. productivity
e. all of the above

e. all of the above

Because changes in the aggregate price level have no effect on aggregate output in the long run, the long-run aggregate supply curve is
a. vertical
b. horizontal
c. fixed
d. negatively sloped
e. positively sloped

a. vertical

The horizontal intercept of the long-run aggregate supply curve is
a. at the origin
b. negative
c. at potential output
d. equal to the vertical intercept
e. always the same as the horizontal intercept of the short-run aggregate supply curve.

c. at potential output

A decrease in which of the following will cause the short-run aggregate supply curve to shift to the left?
a. commodity prices
b. the cost of health care insurance premiums paid by employers
c. nominal wages
d. productivity
e. the use of cost-of-living allowances in labor contracts

d. productivity

That employers are reluctant to decrease nominal wages during economic downturns and raise nominal wages during economic expansions leads nominal wages to be described as
a. long-run
b. unyielding
c. flexible
d. real
e. sticky

e. sticky

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