Aggregate Supply
1
, Unemployment and recessions
• What happens during the recessions?
– Changes in output and employment
– Incomes fall sharply
• 1930s: unemployment rate in the US was above 10 per
cent for about a decade
• 2007-09: unemployment rates rose sharply
• Unemployment is a result of slow growth of aggregate
demand relative to the potential output
– Importance of the potential output: in the long-run,
aggregate supply primarily depends on potential output.
The growth of potential output is crucial to the long-run
economic growth and improvements in the living standards
2
, Potential output
• The long-run level of production is referred to as the potential
output. It is the amount of output that would be produced if
we remove business cycle fluctuations
• It is the highest sustainable level of output for an economy
• It is not the absolute maximum that an economy can produce
• It can be measured as the output that would be produced
when unemployment rate equals a benchmark level known as
the non accelerating inflation rate of unemployment (NAIRU)
• It is also known as full-employment output or the natural rate
of output
• In sum, the natural rate of output is the level of production
around which the economy gravitates in the long-run
3
, Aggregate Supply (AS)
• AS: a view from the production side
– AS curve shows the level of total national output
that will be produced at each possible price level,
keeping other things constant
• Unlike the aggregate demand curve, which is
always downward sloping the aggregate supply
curve depends crucially on the time horizon
– Long-run: AS curve is vertical
– Short-run: AS curve is upward sloping
4
1
, Unemployment and recessions
• What happens during the recessions?
– Changes in output and employment
– Incomes fall sharply
• 1930s: unemployment rate in the US was above 10 per
cent for about a decade
• 2007-09: unemployment rates rose sharply
• Unemployment is a result of slow growth of aggregate
demand relative to the potential output
– Importance of the potential output: in the long-run,
aggregate supply primarily depends on potential output.
The growth of potential output is crucial to the long-run
economic growth and improvements in the living standards
2
, Potential output
• The long-run level of production is referred to as the potential
output. It is the amount of output that would be produced if
we remove business cycle fluctuations
• It is the highest sustainable level of output for an economy
• It is not the absolute maximum that an economy can produce
• It can be measured as the output that would be produced
when unemployment rate equals a benchmark level known as
the non accelerating inflation rate of unemployment (NAIRU)
• It is also known as full-employment output or the natural rate
of output
• In sum, the natural rate of output is the level of production
around which the economy gravitates in the long-run
3
, Aggregate Supply (AS)
• AS: a view from the production side
– AS curve shows the level of total national output
that will be produced at each possible price level,
keeping other things constant
• Unlike the aggregate demand curve, which is
always downward sloping the aggregate supply
curve depends crucially on the time horizon
– Long-run: AS curve is vertical
– Short-run: AS curve is upward sloping
4
