Explain why the aggregate supply (AS) curve slopes upward in the short-run. Explain how the concept of “full employment” is related to a vertical AS curve in the long-run.
In the short run, wages are sticky. So, as price level increases (decreases), ceteris paribus profit of firms increases (decreases) because higher (lower) output price increases (decreases) revenue without increasing (decreasing) labor cost. As a result, quantity supplied by each firm increases (decreases). At an aggregate level, aggregate supply increases (decreases). Therefore AS curve is upward rising in short run.
In the long run, production capacity of all firms is limited by availability of resources, factors of production and existing state of technology. Therefore output is fixed at potential output level. As a result, long run AS curve is vertical.
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