wk5 homework instructor answer key

What assumptions cause the immediate-short-run aggregate supply curve to be horizontal? Why is thelong-run aggregate supply curve vertical? Explain the shape of the short-run aggregate supply curve. Whyis the short-run curve relatively flat to the left of the full-employment output and relatively steep to theright?LO2

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LO2Answer:The immediate short-run supply curve is horizontal because of contractual agreements. These ‘contracts’ for both input and output prices imply that prices do not change along the immediate short-run aggregate supply curve. The long-run aggregate supply curve is vertical (at the full-employment or potential output)because the economy’s potential output is determined by the availability and productivity of real resources, not by the price level. The availability and productivity of real resources is reflected in the prices of inputs, and in the long run these input prices (including wages) adjust to match changes in the price level.

Firms have no incentive to increase production to take advantage of higher prices if they simultaneously face equally higher resource prices. The shape of the short-run supply curve is up sloping Wages and other input prices adjust more slowly than the price level, leaving room for firms to take advantage of these higher prices(temporarily) by increasing output.


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