Principles of Economics- Mankiw (5th) 693

Principles of Economics- Mankiw (5th) 693 - CHAPTER 31 A G...

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CHAPTER 31 AGGREGATE DEMAND AND AGGREGATE SUPPLY 717 The Misperceptions Theory One approach to the short-run aggregate- supply curve is the misperceptions theory. According to this theory, changes in the overall price level can temporarily mislead suppliers about what is happening in the individual markets in which they sell their output. As a result of these short- run misperceptions, suppliers respond to changes in the level of prices, and this response leads to an upward-sloping aggregate-supply curve. To see how this might work, suppose the overall price level falls below the level that people expected. When suppliers see the prices of their products fall, they may mistakenly believe that their relative prices have fallen. For example, wheat farmers may notice a fall in the price of wheat before they notice a fall in the prices of the many items they buy as consumers. They may infer from this obser- vation that the reward to producing wheat is temporarily low, and they may re- spond by reducing the quantity of wheat they supply. Similarly, workers may
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