Question

Why the aggregate supply curve slopes upward in the short run

In the short run, the quantity of output that firms supply can deviate from the natural level of output if the actual price level in the economy deviates from the expected price level. Several theories explain how this might happen.

For example, the misperceptions theory asserts that changes in the price level can temporarily mislead firms about what is happening to their output prices. Consider a soybean farmer who expects a price level of 100 in the coming year. If the actual price level turns out to be 90, soybean prices will ______ , and if the farmer mistakenly assumes that the price of soybeans declined relative to other prices of goods and services, she will respond by   the quantity of soybeans supplied. If other producers in this economy mistake changes in the price level for changes in their relative prices, the unexpected decrease in the price level causes the quantity of output supplied to______ the natural level of output in the short run.

Suppose the economy's short-run aggregate supply (AS) curve is given by the following equation:

Quantity of Output SuppliedQuantity of Output Supplied

=  =

Natural Level of Output+α×(Price LevelActual−Price LevelExpected)Natural Level of Output+α×Price LevelActual−Price LevelExpected

The Greek letter αα represents a number that determines how much output responds to unexpected changes in the price level. In this case, assume that α=$2 billionα=$2 billion. That is, when the actual price level exceeds the expected price level by 1, the quantity of output supplied will exceed the natural level of output by $2 billion.

Suppose the natural level of output is $50 billion of real GDP and that people expect a price level of 100.

On the following graph, use the purple line (diamond symbol) to plot this economy's long-run aggregate supply (LRAS) curve. Then use the orange line segments (square symbol) to plot the economy's short-run aggregate supply (AS) curve at each of the following price levels: 90, 95, 100, 105, and 110.

ASLRAS01020304050607080901001251201151101051009590858075PRICE LEVELOUTPUT (Billions of dollars)

The short-run quantity of output supplied by firms will rise above the natural level of output when the actual price level   the price level that people expected.

Answer 1

(a) When actual price level is less than expected price of 100, prices will Decrease. and farmer will respond by Decreasing the quantity supplied. If others also do the same, then unexpected decrease in price level will make the quantity of output supplied to Fall below the natural output.

(b) Data chart used:

Natural output	α	Price level (Actual)	Price level (Expected)	α x [Price level(Actual) - Price level(Expected)]	Quantity of Output Supplied
(A)	(B)	(C)	(D)	(F) = (B) x [(C) - (D)]	(A) + (F)
50	2	90	100	-20	30
50	2	95	100	-10	40
50	2	100	100	0	50
50	2	105	100	10	60
50	2	110	100	20	70

(c) Graph

(d) Short run output supplied by firms will rise above natural output when actual price level Rises above the price level which the people anticipated.