Question

4. Explain why the aggregate supply curve is positively sloped during the short run and vertical in the long run.

5. List some examples of factors that will shift the aggregate demand curve.

6. List some examples of factors that will shift the long-run aggregate supply curve.

Answer 1

4. Aggregate supply curve shows the relation between between aggregate output levels of the firm's and the general price level. In the short run aggregate supply is positively related with price level. This positive relation shows as price level increases the supply of firms increases. It is because of mainly two reason ; one is in the short run wages do not change that much because of sticky was and as a result if aggregate demand rises price level increases and firm able to supply more. In the short the firms have the capacity to increase output. As wage rate is fixed or do not change that much the firms can increase their profit. Second reason is in the short run input prices other than wages do not change so firm can earn more profit as average price rises with the rise in output level. In the short run firms have the enough capacity to increase the output without much changing in technology, labour and capital. For this reason firms have positively slope aggregate supply curve. The short run aggregate supply equation can be written as Y = Y* + alpha ( P - Pe) , where Y is actual output, Y* is natural level output, P is actual price level and Pe is expected price level.

The aggregate supply curve is vertical in the long run because in the long run firm uses its all capacity at optimum level. If price rises firm can not change the output because there is not enough capacity to increase the output level as price rise. There need to change some factors or technological change to increase the output which actually increases the long run capacity of output. In the long run nominal variable like nominal wage changes. So in long run the output level do not changes with the price level. As long run capacity of output is permanent and short run change is temporary. In the long run there is specific capacity and this capacity can change if some real changes happen.

5. Aggregate demand curve can shift because of various reasons and these are exogenous increase in consumption level, changes in investment can affect aggregate demand. If saving rate of economy of economy changes or marginal propensity to consume changes and and these things can changes the aggregate demand curve. The net export change also can change aggregate demand curve. So any factor which are components of aggregate demand can affect in the shift of aggregate demand. If economy faces that a bunch of population has increased due to certain immigration then aggregate demand will shift rightward.

6. The long run aggregate supply curve can change if there is permanent change occurs. If we get a situation that labour productivity has increased permanently and this increase labour productivity can change the aggregate supply curve outward. If there is technological changes happen then the aggregate supply curve can change. If the labour force or capital increases permanently then long run aggregate supply changes because more labour and capital helps to increase output permanently.