What is the effect of an increase in the price level on the short run aggregate supply curve?

2.         a.         The current state of the economy is shown in Figure 6.  The aggregate-demand curve and short-run aggregate-supply curve intersect at a point to the left of long-run aggregate supply.

b.         A stock market crash leads to a leftward shift of aggregate demand.  The equilibrium level of output and the price level will fall.  Since the quantity of output is less than the natural rate of output, the unemployment rate will rise above the natural rate of unemployment.

c.          If nominal wages are unchanged as the price level falls, firms will be forced to cut back on employment and production.  Over time as expectations adjust, the short-run aggregate supply curve will shift to the right moving the economy back to the natural rate of output.

Figure 6

3.         a.         When the United States experiences a wave of immigration, the labor force increases, so long-run aggregate supply increases as there are more people who can produce output.

b.         When Congress raises the minimum wage to $10 per hour, the natural rate of unemployment rises, so the long-run aggregate-supply curve shifts to the left.

c.          When Intel invents a new and more powerful computer chip, productivity increases, so long-run aggregate supply increases as more output can be produced with the same inputs.

d.         When a severe hurricane damages factories along the East Coast, the capital stock is smaller, so short-run aggregate supply declines.

Except for the hurricane these are permanent changes and will change the LRAS.  We, however, are focusing on the SRAS so you will rarely change the LRAS on a test.  I will emphasis the change is permanent if it is a long-run change.

5.         a.         The statement that "the aggregate-demand curve slopes downward because it is the horizontal sum of the demand curves for individual goods" is false.  The aggregate-demand curve slopes downward because a fall in the price level raises the overall quantity of goods and services demanded through the wealth effect, the interest-rate effect, and the exchange-rate effect.

b.         The statement that "the long-run aggregate-supply curve is vertical because economic forces do not affect long-run aggregate supply" is false.  Economic forces of various kinds (such as population and productivity) do affect long-run aggregate supply.  The long-run aggregate-supply curve is vertical because the price level does not affect long-run aggregate supply.

c.          The statement that "if firms adjusted their prices every day, then the short-run aggregate-supply curve would be horizontal" is false.  If firms adjusted prices quickly and if sticky prices were the only possible cause for the upward slope of the short-run aggregate supply curve, then the short-run aggregate-supply curve would be vertical, not horizontal.  The short-run aggregate supply curve would be horizontal only if prices were completely fixed.

d.         The statement that "whenever the economy enters a recession, its long-run aggregate-supply curve shifts to the left" is false.  An economy could enter a recession if the aggregate-demand curve or the short-run aggregate-supply curve shift to the left.

Figure 10

10.        a.         If households decide to save a larger share of their income, they must spend less on consumer goods, so the aggregate-demand curve shifts to the left, as shown in Figure 10.  The equilibrium changes from point A to point B, so the price level declines and output declines.

b.         If Florida orange groves suffer a prolonged period of below-freezing temperatures, the orange harvest will be reduced.  This is represented in Figure 11 by a shift to the left in the short-run aggregate-supply curve.  The equilibrium changes from point A to point B, so the price level rises and output declines.

Figure 11

Figure 12

c.          If increased job opportunities cause people to leave the country, the short-run aggregate-supply curve will shift to the left because there are fewer people producing output.  The aggregate-demand curve will shift to the left because there are fewer people consuming goods and services.  The result is a decline in the quantity of output, as Figure 12 shows.  Whether the price level rises or declines depends on the size of the shifts in the aggregate-demand curve and the short-run aggregate-supply curve.

11.        a.         When the stock market declines sharply, wealth declines, so the aggregate-demand curve shifts to the left, as shown in Figure 13.  In the short run, the economy moves from point A to point B, as output declines and the price level declines.  In the long run, the short-run aggregate-supply curve shifts to the right to restore equilibrium at point C, with unchanged output and a lower price level compared to point A.

Figure 13

Figure 14

b.         When the federal government increases spending on national defense, the rise in government purchases shifts the aggregate-demand curve to the right, as shown in Figure 14.  In the short run, the economy moves from point A to point B, as output and the price level rise.  In the long run, the short-run aggregate-supply curve shifts to the left to restore equilibrium at point C, with unchanged output and a higher price level compared to point A.

Figure 15

            c.          When a technological improvement raises productivity, the long-run and short-run aggregate-supply curves shift to the right, as shown in Figure 15.  The economy moves from point A to point B, as output rises and the price level declines.  Yes! this is a very difficult problem.

Figure 16

d.         When a recession overseas causes foreigners to buy fewer U.S. goods, net exports decline, so the aggregate-demand curve shifts to the left, as shown in Figure 16.  In the short run, the economy moves from point A to point B, as output declines and the price level declines.  In the long run, the short-run aggregate-supply curve shifts to the right to restore equilibrium at point C, with unchanged output and a lower price level compared to point A.

12.        a.         If firms become optimistic about future business conditions and invest a lot, the result is shown in Figure 17.  The economy begins at point A with aggregate-demand curve AD1 and short-run aggregate-supply curve AS1.  The equilibrium has price level P1 and output level Y1.  Increased optimism leads to greater investment, so the aggregate-demand curve shifts to AD2.  Now the economy is at point B, with price level P2 and output level Y2.  The aggregate quantity of output supplied rises because the price level has risen and people have misperceptions about the price level, wages are sticky, or prices are sticky, all of which cause output supplied to increase.

b.                   Over time, as the misperceptions of the price level disappear, wages adjust, or prices adjust, the short-run aggregate-supply curve shifts up to AS2 and the economy gets to equilibrium at point C, with price level P3 and output level Y1.  The quantity of output demanded declines as the price level rises.

Figure 17

c.          The investment boom might increase the long-run aggregate-supply curve because higher investment today means a larger capital stock in the future, thus higher productivity and output.

What is the effect of an increase in the price level on the short

What happens to short

What is the effect of a price level change in the short

What happens to the LRAS curve when there is an increase in price level?