PRINCIPLES OF MACROECONOMICS PART III The Core of Macroeconomic Theory TENTH EDITION CASE FAIR OSTER © 2012 Pearson Education, Inc Publishing as Prentice Hall Prepared by: Fernando Quijano & Shelly ofTefft 40 PART III The Core of Macroeconomic Theory © 2012 Pearson Education, Inc Publishing as Prentice Hall of 40 Aggregate Supply and the Equilibrium Price Level 13 CHAPTER OUTLINE The Aggregate Supply Curve The Aggregate Supply Curve: A Warning Aggregate Supply in the Short Run Shifts of the Short-Run Aggregate Supply Curve The Equilibrium Price Level The Long-Run Aggregate Supply Curve Potential GDP Monetary and Fiscal Policy Effects Long-Run Aggregate Supply and Policy Effects PART III The Core of Macroeconomic Theory Causes of Inflation © 2012 Pearson Education, Inc Publishing as Prentice Hall Demand-Pull Inflation Cost-Push, or Supply-Side, Inflation Expectations and Inflation Money and Inflation Sustained Inflation as a Purely Monetary Phenomenon The Behavior of the Fed Targeting the Interest Rate The Fed’s Response to the State of the Economy Fed Behavior Since 1970 Interest Rates Near Zero Inflation Targeting Looking Ahead of 40 The Aggregate Supply Curve aggregate supply The total supply of all goods and services in an economy The Aggregate Supply Curve: A Warning PART III The Core of Macroeconomic Theory aggregate supply (AS) curve A graph that shows the relationship between the aggregate quantity of output supplied by all firms in an economy and the overall price level The aggregate supply curve is not a market supply curve, and it is not the simple sum of all the individual supply curves in the economy Because many firms in the economy set prices as well as output, we can say an “aggregate supply curve” is really a “price/output response” curve—a curve that traces out the price decisions and output decisions of all firms in the economy under a given set of circumstances © 2012 Pearson Education, Inc Publishing as Prentice Hall of 40 The Aggregate Supply Curve Aggregate Supply in the Short Run PART III The Core of Macroeconomic Theory FIGURE 13.1 The Short-Run Aggregate Supply Curve In the short run, the aggregate supply curve (the price/output response curve) has a positive slope At low levels of aggregate output, the curve is fairly flat As the economy approaches capacity, the curve becomes nearly vertical At capacity, Y*, the curve is vertical © 2012 Pearson Education, Inc Publishing as Prentice Hall of 40 PART III The Core of Macroeconomic Theory Which of the following factors affects the shape of the AS curve? a Capacity constraints b The price of output c Cost shocks d Economic growth © 2012 Pearson Education, Inc Publishing as Prentice Hall of 40 PART III The Core of Macroeconomic Theory Which of the following factors affects the shape of the AS curve? a Capacity constraints b The price of output c Cost shocks d Economic growth © 2012 Pearson Education, Inc Publishing as Prentice Hall of 40 The Aggregate Supply Curve Aggregate Supply in the Short Run Why an Upward Slope? Wages are a large fraction of total costs and wage changes lag behind price changes This gives us an upward sloping short-run AS curve PART III The Core of Macroeconomic Theory Why the Particular Shape? At some level the overall economy is using all its capital and all the labor that wants to work at the market wage At this level (Y*), the AS curve is vertical At low levels of output, the AS curve is flatter Small price increases may be associated with relatively large output responses We may observe relatively “sticky” wages upward at this point on the AS curve © 2012 Pearson Education, Inc Publishing as Prentice Hall of 40 The Aggregate Supply Curve PART III The Core of Macroeconomic Theory Shifts of the Short-Run Aggregate Supply Curve cost shock, or supply shock A change in costs that shifts the shortrun aggregate supply (AS) curve FIGURE 13.2 Shifts of the Short-Run Aggregate Supply Curve © 2012 Pearson Education, Inc Publishing as Prentice Hall of 40 The Equilibrium Price Level equilibrium price level The price level at which the aggregate demand and aggregate supply curves intersect PART III The Core of Macroeconomic Theory FIGURE 13.3 The Equilibrium Price Level At each point along the AD curve, both the money market and the goods market are in equilibrium Each point on the AS curve represents the price/ output decisions of all the firms in the economy P0 and Y0 correspond to equilibrium in the goods market and the money market and to a set of price/output decisions on the part of all the firms in the economy © 2012 Pearson Education, Inc Publishing as Prentice Hall 10 of 40 ... Publishing as Prentice Hall of 40 PART III The Core of Macroeconomic Theory Which of the following factors affects the shape of the AS curve? a Capacity constraints b The price of output c Cost shocks... Prentice Hall of 40 PART III The Core of Macroeconomic Theory Which of the following factors affects the shape of the AS curve? a Capacity constraints b The price of output c Cost shocks d Economic... planned aggregate expenditure of AE1 and aggregate demand of AD1, equilibrium output is Y1 A shift of planned aggregate expenditure to AE2, corresponding to a shift of the AD curve to AD2, causes