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Deriving Aggregate Supply

Deriving Aggregate Supply - curve is a vertical line as...

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Deriving Aggregate Supply Introduction to Aggregate Supply we learned that aggregate demand is the total demand for goods and services in an economy. But the aggregate demand curve alone does not tell us the equilibrium price level or the equilibrium level of output. In order to obtain this information, we need to add the aggregate supply curve to the diagram containing the aggregate demand curve. Then, and only then, do the equilibrium values of the economy in the AS-AD model appear. The aggregate supply curve shows the relationship between the price level and the quantity of goods and services supplied in an economy. The equation for the upward sloping aggregate supply curve, in the short run, is Y = Ynatural + a(P - Pexpected). In this equation, Y is output, Ynatural is the natural rate of output that exists when all productive factors are used at their normal rates, a is a constant greater than zero, P is the price level, and Pexpected is the expected price level. This equation holds only in the short run because in the long run the aggregate supply
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Unformatted text preview: curve is a vertical line, as output is dictated by the factors of production alone. But what does the equation for the aggregate supply curve mean? Basically, this equation means that output deviates from the natural rate of output when the price level deviates from the expected price level. The constant, a, shows how much output changes due to unexpected deviation in the price level. It is also important to notice that the slope of the aggregate supply curve is (1/a). Figure %: Graph of the aggregate supply curves depicts the short-run aggregate supply curve and the long- run aggregate supply curve. Notice that the axes are the same as for the aggregate demand curve. The vertical axis is the price level. The horizontal axis is output or income. Also notice that the short-run aggregate supply curve is downward sloping with slope equal to (1/a) while the long-run aggregate supply curve is vertical with no slope....
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