AS AD Model Part 2 (part 3 On PowerPoint) Flashcards
3 reasons why SRAS slopes upward
Some stick prices
Sticky wages
Imperfect info (misperceptions)
Some Sticky prices
Some sticky, some flexible price who can change at short notice
Therefore SRAS upwards sloping.
Sticky wages, why are they fixed, and why do sticky prices mean SRAS is upward sloping.
Slow to adjust due to contracts of employment.
When price is high, real labour costs fall (W/P), so they will hire more as price increases to produce more output
Therefore upwards sloping
Why Imperfect information creates upward SRAS
Firms do not know every other prices in economy.
If they think their price of good increased, they increase output, vice versa.
Therefore upward sloping
Fiscal policy change: decrease in gov spending. Or negative demand shock
AD shifts down, Move from long run to short run equilibrium. Now IN SHORT RUN WE HAVE flexible prices and sticky wages. Price falls as demand lowers it.
As wages are sticky (contracts), covering costs is more difficult as sell less at lower price, so reduce production. Creates recessionary gap Y2, Y1.
Workers then accept lower wages so extend along AD2 to long run output but at a lower wage. SRAS shifts down to meet in line with long run
Positive demand shock
Increase in AD, firms increase prices, extend along SRAS and in turn hire more workers. (As P increased real wages fall W/P) (Unemployment decreases below its natural rate at LRAS.
Then, as price has increased workers dissatisfied as real wage (W/P) is now lower as hasn’t adjusted to new PL. (inflationary gap between y1 y2)
Then wages increase, increased costs of production so SRAS shifts up too. Meet back at LRAS output but wages and prices are both higher now
Why are firms willing to supply more output at a higher price level
Because output prices rise relative to input prices, so profit margins for firms rise
Why do firms supply less at a lower price level
Profit margins fall, harder to cover costs which remain relatively constant in the short run (Sticky wages-reasons for them explained earlier-contracts and W/P)
Negative supply shock with upward sloping SRAS
SRAS shifts left
P increases, Y falls, unemployment up.
Workers willing to accept lower wages, SRAS returns back down to original P and Y.
Unlike demand shocks, where we end up at LRAS output but price changes.
Positive supply shock with upward sloping SRAS
Move to long run to short run with SRAS shift right.
Price falls, Y increases, unemployment falls, as real wages fall so hire more.
Workers demand higher wages, SRAS returns back to original P and Y
