5 . Why the aggregate supply curve slopes upward in the short run In the short run, the quantity of output that rms 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 stickyprice theory asserts that the output prices of some goods and services adjust slowly to changes in the price level. Suppose rms announce the prices for their products in advance, based on an expected price level of 100 for the coming year. Many of the rms 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 rms that rely on catalogs will respond by V the quantity of output they supply. If enough rms 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 LevelActM; Rice Levelgzm) The Greek letter 0 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 11 O. 125 120 115 110 105 100 P RICE LEVE L 75 10 20 30 40 50 60 70 OUTPUT (Billions of dollars) 3090 100 AS LRAS The short-run quantity of output supplied by firms will rise above the natural level of output when the actual price level level that people expected. v the price V 6 . Determinants of aggregate supply The following graph shows a decrease in short-run aggregate supply (AS) in a hypothetical economy where the currency is the dollar. Specifically, the short-run aggregate supply curve shifts to the left from AS, to AS2, causing the quantity of output supplied at a price level of 100 to fall from $200 billion to $150 billion.\fThe following table lists several determinants of short-run aggregate supply. Fill in the table by indicating the changes in the determinants necessary to decrease short-run aggregate supply. Change Needed to Decrease AS Inflation expectations Tax rates Burdensome regulations8 . Economic fluctuations II The following graph shows the short-run aggregate supply curve (AS), the aggregate demand curve (AD), and the long-run aggregate supply curve (LRAS') for a hypothetical economy. Initially, the expected price level is equal to the actual price level, and the economy is in long-run equilibrium at its natural level of output, $100 billion. Suppose war in the world's main oil-producing region sharply reduces the wand oil supply, causing oil prices to rise and increasing the costs of producing goods and services in this economy. Use the graph to hefp you answer the questions about the short-run and long-run effects of the Increase in production costs that follow. (Note: You will not be graded on any adjustments made to the graph.) Hint: For simplicity, ignore any possible impact of the higher oil prices on the natural level of output. 120 LRAS O 115 AS AD 110 105 AS 100 PRICE LEVEL A 95 LRAS 90 AD 85 80 80 85 90 95 100 105 110 115 120 OUTPUT (Billions of dollars)The short-run economic outcome resulting from the increase in production costs is known as Now suppose that the government immediately pursues an accommodationicy by increasing government purchases in response to the short-run economic impact of the higher oil prices. In the long run, when the government pursues accommodation, the output in the economy will be $ billion and the price level will be? Graph A Graph B LRAS LRAS Aggregate Supply Aggregate Supply Price Level Price Level Aggregate Demand Aggregate Demand Quantity of Output Quantity of OutputWhich of the graphs represents the state of the economy before this pronouncement? 0 Graph A 0 Graph B True or False: President Roosevelt was trying to decrease aggregate demand. 0 True 0 False 11 . Recession True or False: If firms adjusted their prices every day, then the short-run aggregate-supply curve would be horizontal. O True O False