Question 6

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 misperceptions theory asserts that changes in the price level can temporarily mislead firms about what is happening to their output prices. Consider a soybean farmer who expects a price level of 100 in the coming year. If the actual price level turns out to be 90, soybean prices will W , and if the farmer mistakenly assumes that the price of soybeans declined relative to other prices of goods and services, she will respond by W the quantity of soybeans supplied. If other producers in this economy mistake changes in the price level for changes in their relative prices, the unexpected decrease in the price level causes the quantity of output supplied to W 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 Qutput Supplied = Natural Level of Output + a x (Price Level gqya Price Level prpected) The Greek letter & represents a number that determines how much output responds to unexpected changes in the price level. In this case, assume that & = $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 $50 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 (A5) curve at each of the following price levels: 80, 95, 100, 105, and 110. 126 T 120 + 115 -+ 110 + : 1056 -+ LRAS 100 + FRICE LEWEL o0 0 0 20 30 40 50 60 70 &80 80 100 QUTPUT (Billions of dollars) The short-run quantity of output supplied by firms will fall short of the natural level of output when the actual price level w the price level that people expected. 7. 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 ASi to $2, causing the quantity of output supplied at a price level of 100 to fall from $200 billion to $150 billion. (?) 200 AS, 175 AS 150 125 100 PRICE LEVEL 75 50 50 100 150 200 250 300 350 400 QUANTITY OF OUTPUT The following table lists several determinants of short-run aggregate supply. Complete the table by selecting the changes in each scenario necessary to decrease short-run aggregate supply. Change Necessary to Decrease AS Regulations on the firm Human capital Input prices