Chapter 27: Problem 2

Your study partner is confused by the upward-sloping short-run aggregate supply curve and the vertical longrun aggregate supply curve. How would you explain this?

Short Answer

Expert verified

The key difference between the SRAS and LRAS curves is that the SRAS curve shows a positive relationship between price level and output in the short run, with firms responding to changing price levels by adjusting production. In contrast, the LRAS curve represents the economy's potential output in the long run, which is independent of the price level and determined by the economy's resources, technology, and institutional structures.

Step by step solution

Introduce the Aggregate Supply curve

The aggregate supply curve shows the total quantity of goods and services that firms in an economy are willing to produce at different price levels. It demonstrates the relationship between the overall price level and the total output an economy produces. There are two types of aggregate supply curves: short-run and long-run.

Explain the Short-Run Aggregate Supply curve

The short-run aggregate supply (SRAS) curve is upward-sloping, which shows that in the short run, the quantity of goods and services firms are willing to produce increases as the overall price level rises. This happens because, in the short run, some inputs or factors of production (e.g., labor, capital) remain fixed, while others can be adjusted. As prices rise, firms increase production because it becomes more profitable to produce goods and services. Higher prices cover their higher costs (such as wages and raw materials) and contribute to increased revenue. Inflation or price level increases can also be due to a larger quantity of money, higher production costs, or higher demand for goods and services.

Explain the Long-Run Aggregate Supply curve

The long-run aggregate supply (LRAS) curve is vertical, meaning that in the long run, the quantity of goods and services firms are willing to produce does not depend on the overall price level. This happens because, in the long run, all inputs or factors of production are variable, and firms can adjust their production capacity. Additionally, the economy reaches a point where it is producing at its full potential output (also known as potential GDP), and this output level is determined by the economy's resources, technology, and institutional structures. In the long run, changes in the price level do not affect this potential output.

Compare SRAS and LRAS

The key difference between the SRAS and LRAS curves is that SRAS shows a positive relationship between price level and output in the short run, while LRAS shows the economy's potential output in the long run, which is independent of the price level. The upward-sloping SRAS curve represents the fact that firms respond to changing price levels by adjusting production in the short run, while the vertical LRAS curve represents the economy's potential output that is not influenced by price level changes in the long run.

Summarize the explanation

In summary, the upward-sloping short-run aggregate supply curve demonstrates that firms are willing to produce more goods and services as the price level increases in the short run, while the vertical long-run aggregate supply curve shows that the economy's potential output level is independent of price level changes in the long run. The SRAS curve captures the short-term adjustments firms make in response to changing prices, while the LRAS curve represents the economy's long-term potential output given its resources, technology, and institutional arrangements.