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Chapter 24: Problem 3

Why does the short-run aggregate supply curve slope upward?

Short Answer

Expert verified
The short-run aggregate supply curve slopes upwards due to the Sticky-Wage Theory, Sticky-Price Theory, and the Misperceptions Theory. The Sticky-Wage Theory proposes that when the overall price level increases, real wages decrease, encouraging businesses to increase output. The Sticky-Price Theory suggests that firms with flexible prices will raise their prices and output when the price level rises, whereas those with sticky prices will be slower to react, causing aggregate supply to increase. Lastly, the Misperceptions Theory infers that firms might mistake changes in the overall price level as relative changes in their prices, leading to an increase in production.

Step by step solution

01

Understand the Question and Gather Information

The exercise is asking why the short-run aggregate supply curve slopes upwards. The aggregate supply curve represents the total quantity of goods and services firms are willing and able to supply within an economy at different price levels, holding all else constant. In the short run, the aggregate supply curve slopes upward indicating a positive relationship between the price level and the quantity of goods and services supplied. This phenomenon is explained by several theories.
02

Discuss the Sticky-Wage Theory

Sticky-Wage Theory assumes that the wages of workers are 'sticky' or slow to respond to changes in supply and demand. This means that in the short run, real wages may be 'too high' leading to unemployment or 'too low' leading to labor shortages. When the overall price level increases, real wages decline, making labour cheaper. Businesses respond by increasing output, hence, the aggregate supply curve slopes upward.
03

Discuss the Sticky-Price Theory

According to the Sticky-Price Theory, prices of some goods and services also adjust sluggishly in response to changes in demand or supply. When the overall price level increases, firms with flexible prices will raise their prices and output, but firms with sticky prices are slower to respond. As a result, aggregate supply increases, which explains the upward slope.
04

Discuss the Misperceptions Theory

The Misperceptions Theory suggests that firms may temporarily confuse changes in the overall price level with changes that are specific to their firm or industry. If the overall price level rises more than expected, firms perceive this as a relative increase in their prices, leading them to increase production. This results in a higher level of aggregate supply, contributing to the upward slope of the curve.

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Most popular questions from this chapter

What variables cause the short-run aggregate supply curve to shift? For each variable, identify whether an increase in that variable will cause the short- run aggregate supply curve to shift to the right or to the left.

An economics student makes the following statement: "It's easy to understand why the aggregate demand curve is downward sloping: When the price level increases, consumers substitute into buying less expensive products, which decreases total spending in the economy." Briefly explain whether you agree.

The subtitle of a Wall Street Journal article about the economy in the euro zone (the 19 European countries that use the euro as their currency) was "Fourth-Quarter Output, Lowest Unemployment in Seven Years, Higher Inflation Eases Some Concerns." Use an aggregate demand and aggregate supply graph to show how the euro zone could experience both lower unemployment and higher inflation. Briefly explain what you are showing in your graph.

(Related to the Apply the Concept on page 841) In early 2009, Christina Romer, who was then the chair of the Council of Economic Advisers, and Jared Bernstein, who was then an economic adviser to Vice President Joseph Biden, forecast how long they expected it would take for real GDP to return to potential GDP, assuming that Congress passed fiscal policy legislation proposed by President Obama: It should be understood that all of the estimates presented in this memo are subject to significant margins of error. There is the obvious uncertainty that comes from modeling a hypothetical package rather than the final legislation passed by the Congress. But there is the more fundamental uncertainty that comes with any estimate of the effects of a program. Our estimates of economic relationships ... are derived from historical experience and so will not apply exactly in any given episode. Furthermore, the uncertainty is surely higher than normal now because the current recession is unusual both in its fundamental causes and its severity. Why would the causes of a recession and its severity affect the accuracy of forecasts of when the economy would return to potential GDP?

As output increases along the short-run aggregate supply curve, briefly explain what happens to the natural rate of unemployment and to the cyclical rate of unemployment.
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