If the stock of capital declines the as curve will

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If the stock of capital declines, the AS curve will shift to the left. v. Public policy can shift the AS curve. vi. Weather, wars, and natural disasters 1. Changes in weather can shift the AS curve. 2. If an economy is damaged by war or natural disaster, the AS curve will shift to the left. 3. Whenever part of the resource base of an economy is reduced or destroyed. IV. The equilibrium price level a. Equilibrium price level - the price level at which that aggregate demand and aggregate supply curves intersect. b. *The point at which the AS and AD curves intersect corresponds to equilibrium in the goods and money markets and to a set of price/output decisions on the part of all the firms in the economy.
V. The long run aggregate supply curve a. For the AS curve not to be vertical, some costs must lag behind increases in the overall price level. If all prices change at the same rate, the level of aggregate output does not change. b. Many economists believe costs lag behind price-level changes in the short run but ultimately move with the overall price level. i. For example, wage rates tend to move very closely with the price level over time. ii. If the price level increases at a steady rate, inflation may come to be fully anticipated and built into most labor contracts. c. Recall, however, that the movement along the upward-sloping AS curve as Y increases assumes that some cost lag behind the increase in the overall price level. d. Assume now that costs fully adjust to prices in the long run. e. *If wage rates and other costs fully adjust to changes in prices in the long run, then the long run AS curve is vertical. f. Potential GDP i. The vertical portion of the short run AS curve exists because there are physical limits to the amount that an economy can produce in any given period time period. ii. At the physical limit, all plants are operating around the clock, many workers are on overtime, and there is no cyclical unemployment iii. Potential output or potential GDP - the level of aggregate output that can be sustained in the long run without inflation. iv. As the economy approaches sort run capacity, wage rates tend to rise as firms try to attract more people into the labor force and to induce more workers to work overtime. v. Rising costs shift the short run curve to the left and drive output back to Y*. vi. Short run equilibrium below potential GDP 1. Those who believe the aggregate supply curve is vertical in the long run believe that when short run equilibrium exist below Y*, GDP will tend to rise- just as GDP tends to fall when short run equilibrium exists above Y*. a. The argument is that when the economy is operating below full employment with excess capacity and high unemployment, input prices are likely to fall. b. A decline in input prices shifts the aggregate supply curve to the right, causing the price level to fall and the level of real GDP to rise back to Y*. c. This automatic adjustment works only if input prices fall when excess capacity
and unemployment exist.

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