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QUESTION:

6. Why the aggregate supply curve slopes upward in the short run

In the short run, the quantity of output supplied by firms can deviate from the natural level of output if the actual price level deviates from the expected price level in the economy. A number of theories explain reasons why 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 110. 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 will respond by    the quantity of output they supply. If enough firms face high costs of adjusting prices, the unexpected increase in the price level causes the quantity of output supplied to    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+α×Price LevelActual−Price LevelExpected
The Greek letter α represents a number that determines how much output responds to unexpected changes in the price level. In this case, assume that α=$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 110.
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: 100, 105, 110, 115, and 120.
The short-run quantity of output supplied by firms will fall short of the natural level of output when the actual price level    the price level that people expected.

ANSWER:

In the short run, the quantity of output supplied by firms can deviate from the natural level of output if the actual price level deviates from the expected price level in the economy. A number of theories explain reasons why 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 110. Faced with high menu costs, the firms that rely on catalog sales choose not to adjust their prices. Sales from catalogs willincrease  Correct , and firms that rely on catalogs will respond byraising  Correct the quantity of output they supply. If enough firms face high costs of adjusting prices, the unexpected increase in the price level causes the quantity of output supplied toexceed  Correct the natural level of output in the short run.
Points:
1 / 1
Close Explanation
Explanation:
According to the sticky-price theory, the short-run aggregate supply curve slopes upward because the prices of some products adjust slowly to economic conditions. Some firms set prices for prolonged periods of time because they face high menu costs when prices are adjusted frequently. If the price level turns out to be lower than people expected, the prices of products of firms with more flexible pricing options will be low compared to the prices of products of firms that face high menu costs. Firms with rigid prices will see their sales decline and will cut back on production. An unexpectedly high price level has the opposite effect. Flexible firms will adjust their prices upward, while prices at sticky-price firms will lag behind. Sticky-price firms will see their sales increase because of their relatively low prices, causing them to increase production.
Suppose the economy's short-run aggregate supply (AS) curve is given by the following equation:
Quantity of Output Supplied = Natural Level of Output+α×Price LevelActual−Price LevelExpected
The Greek letter α represents a number that determines how much output responds to unexpected changes in the price level. In this case, assume that α=$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 110.
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: 100, 105, 110, 115, and 120.
Points:
1 / 1
The short-run quantity of output supplied by firms will fall short of the natural level of output when the actual price levelfalls short of  Correct the price level that people expected.
Points:
1 / 1
Close Explanation
Explanation:
The long-run aggregate supply (LRAS) curve reflects the fact that the money supply and the price level—nominal variables—have no impact on the quantity of goods and services—a real variable—that the economy produces in the long run. The long-run aggregate supply curve is therefore a vertical line at the economy's natural level of output ($60 billion). In the long run, the economy's natural level of output is determined by the size of its labor force, its stocks of human and physical capital, its natural resources, and its technological knowledge.
In the short run, the quantity of output supplied by firms fluctuates around the natural level of output when the actual price level turns out to be different from what people expected. For example, an unexpectedly low price level of 100 causes firms to supply a quantity of output less than the natural level of output in the short run. The short-run aggregate supply curve is therefore upward sloping:
Quantity of Output Supplied = Natural Level of Output+α×Price LevelActual−Price LevelExpected
 = $60 billion+$2 billion×100−110
 = $60 billion+−$20 billion
 = $40 billion
If the actual price level turns out to be equal to what people expected, output will be equal to the natural level of output:
Quantity of Output Supplied = $60 billion+$2 billion×110−110
 = $60 billion
An unexpectedly high price level of 120 causes firms to supply a quantity of output that exceeds the natural level of output in the short run:
Quantity of Output Supplied = $60 billion+$2 billion×120−110
 = $60 billion+$20 billion
 = $80 billion
Using the same formula for the remaining price levels produces a short-run aggregate supply curve that goes through the coordinates (40, 100); (50, 105); (60, 110); (70, 115); and (80, 120).

Posted by Cleveland on September 16, 2024
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