Chapter 14 Aggregate Supply and Economic Growth

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Chapter 14 -- Aggregate Supply and Economic Growth

• This chapter -- looks at the effects of changes
  in Aggregate Supply, both short-run and long-run.
  
• Correspondingly, we examine the causes that shift
  the AS curve and the LAS curve, and their effects
  on the economy.

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Short-Run Aggregate Supply (AS)

• Short-Run Aggregate Supply (AS) -- the sum of
  all the newly produced US final goods and
  services that firms wish to produce (real GDP
  supplied), given inflexible input prices
  (especially the nominal wage rate).

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Short-Run Aggregate Supply (AS) -- Causes

• Price Level (P)
• P? ? AS?
• Price of Energy (PE)
• PE? ? AS?
• The Nominal Wage Rate (W)
• W? ? AS?

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Short-Run Aggregate Supply -- More Causes

• Labor Productivity (PROD), defined as output per
  labor hour.
• PROD? ? AS?
• Capital Stock (K) -- all the existing physical
  plant and equipment used by firms to produce
  goods and services.
• K? ? AS?

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Formalizing the AS Curve

• Upward sloping when graphed against Price Level
  (P).
• Changes in a cause other than P -- described as
  shifting the AS curve.
• Changes in variables that increase AS, or
  enhance production, shift the AS curve rightward.
• Changes in variables that decrease AS, or hinder
  production, shift the AS curve leftward.

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Example 1 -- A Supply
Shock

• Example 1 -- The price of energy (PE) increases
  (energy crisis in US, 1973 and 1979).
• PE? hinders production, reduces Short-Run
  Aggregate Supply.
• Therefore the AS curve shifts leftward.
• As a result, Y?, P? (Yuck!!).

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Example 2 -- Productivity The Magic Variable

• Example 2 -- Labor productivity (PROD) increases
  (late 1990s, 2000 in US).
• PROD? increases Short-Run Aggregate Supply.
• Therefore the AS curve shifts rightward.
• As a result, Y?, P? (Wow!!).

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Example 3 -- The Wage-Price
Spiral

• Example 3 -- Two Changes.
• (1) Increases in (G - T) (increase in
• government purchases, or decrease
• in taxes) move Y beyond YF and
• accelerate inflation.
• (2) Labor wants their wages to keep
• pace with inflation, so they get
• larger than normal wage increases
• (W?).

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Describing The Wage-Price Spiral -- AD-AS Model

• (1) Increase in (G - T) shifts AD curve
• rightward, Y? beyond YF, P?.
• (2) The rise in W is described by a
• shift of the AS curve leftward.
• As a result Y returns to its previous level, P?
  even more.
• Creates a situation called Stagflation
  inflation with stagnant output.
• Tends to be a continuing process,
  i.e. spiral.

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The Long-Run Aggregate Supply (LAS) Curve

• Vertical when plotted versus the price level (P).
• Vertical at the full sustainable level of real
  GDP (YF)

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Shifting the LAS Curve

• Curve shifts either rightward (increase in LAS)
  or leftward (decrease in LAS)
• Variables that shift the LAS curve rightward,
  therefore, increase YF.
• Variables that shift the LAS curve leftward,
  therefore, decrease YF.

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Shift Variables LAS Curve (Variables That
Change YF)

• Labor Productivity (PROD)
• PROD? ? LAS?
• Capital Stock (K) -- all the existing plant and
  equipment used by firms to produce goods and
  services.
• K? ? LAS?

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More Shifters LAS Curve (Variables That Change
YF)

• Size of Labor Force
• Labor Force? ? LAS?
• Tastes/Preferences Toward Work.
• Work? ? LAS?
• Transfer Payments (TP)
• TP? ? LAS?

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Application 1 What Makes YF Grow in the US?

• Steady Growth in the Following Variables
• Labor Force
• Capital Stock Accumulation
• Labor Productivity
• Average Growth of YF in US 2.5
  per year
• Not the same for all countries in the world.

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Application 2 Effects of a Productivity Boom

• Suppose that increased technology (e.g.
  computerization) makes labor more productive.
• Productivity growth increases, shifts LAS curve
  rightward more than usual.

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Application 2 Continued -- Effects on YF

• Therefore YF in the US grows at more than 2.5.
• This implies that actual real GDP (Y) can enjoy
  higher growth without accelerating inflation.
• Very nice!!

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Goals for the Economy

• Fluctuations -- seek to get the economy (Y) as
  close to possible to a given YF (examples
  standard fiscal and monetary policy) ? shift AD
  curve.
• Economic Growth -- seek to increase the full
  sustainable level of real GDP (YF) ? shift LAS
  curve.

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Ways to Increase Economic Growth (Increase YF)

• Capital Stock?
• Labor Productivity?
• Labor Force?
• Household Attitudes Toward Work?
• Transfer Payments?

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Trying to Increase Labor Productivity

• Increase Research and Development.
• Increase Labor Quality (Human Capital)
  Education and Vocational Training.
• Promote Investment (plant and equipment)!!!
• -- Tends to Incorporate New
• Technology.
• -- Also expands the capital stock.