In the short run, the quantity of output that firms 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, thesticky-price theoryasserts 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 90. Faced with high menu costs, the firms that rely on catalog sales choose not to adjust their prices. Sales from catalogs will _______________(fall/remain the same/rise), and firms that rely on catalogs will respond by ____________ (reducing/increasing) the quantity of output they supply. If enough firms face high costs of adjusting prices, the unexpected decrease in the price level causes the quantity of output supplied to __________ (rise above/fall below) 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:

QuantityofOutputSupplied=NaturalLevelofOutput+?(PriceLevelActual?PriceLevelExpected)

The Greek letter? represents a number that determines how much output responds to unexpected changes in the price level. In this case, assume that?=$2billion. 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 110. 125 120 AS 115 110 105 LRAS PRICE LEVEL 100 95 85 75 10 20 30 40 50 60 70 80 90 100 OUTPUT (Billions of dollars)