5 . 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-wage theory asserts that output prices adjust more quickly to changes in the price level than wages do, in part because of longterm wage contracts. Suppose a firm signs a contract agreeing to pay its workers $15 per hour for the next year, based on an expected price level of 100. If the actual price level turns out to be 110, the firm's output prices will V , and the wages the firm pays its workers will remain fixed at the contracted level. The firm will respond to the unexpected increase in the price level by Y the quantity of output it supplies. If many firms face similarly rigid wage contracts, the unexpected increase in the price level causes the quantity of output supplied to Y 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: Qmmliry of Output Supplied = Normal Level UfOutpm' + a X (Price Levelm-mai Price Levelpmgd} The Greek letter (1 represents a number that determines how much output responds to unexpected changes in the price level. In this case, assume that a = $4 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 $4 billion. Suppose the natural level of output is $40 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 1.20. 125 120 AS 115 110 105 LRAS 100 PRICE LEVEL 95 90 85 80 75 0 10 20 30 40 50 60 70 80 90 100 OUTPUT (Billions of dollars) The short-run quantity of output supplied by firms will exceed the natural level of output when the actual price level the price level that people expected