The extended AD-AS model and the Phillip's curve.

THE EXTENDED AS-AD MODEL

In order to understand the effects of inflation in the long return, lets first analyze the long run collect demand (AD) and aggregate supply (AS) curves in the long run through the extended AS-AD model.

SHORT-RUN AND LONG-RUN AGGREGATE SUPPLY

Short Run

It is the gunpoint in which titular reinforcement (and other input termss) remain placed as the price level increases or decreases.

Causes of improve nominal wages:

* Workers may not immediatel y be mindful of the extent that inflation or deflation has changed their real wages, and thus they may not adjust their labor supply decisions and wage demands accordingly.

* galore(postnominal) employees are hired under fixed-wage contracts. For unionized employees their prospective wages are set for 2 years. Other professionals too cave in annual contracts.

For the reasons mentioned above, price- level changes dont immediately give rise to changes in nominal wages in the on the spur of the moment run.

The short check can also be explained with the help of a graph. In this graph, only the intermediate range of the AS curve has been considered. In the short run, nominal wages a re fixed and based on price level P1 and the expectation that it give continue.



An increase in the price level from P1 to P2 increases profits and turnout moving the economy from a1 to a2; a decrease in the price level from P1 to P3 reduces profits and real output, moving the economy from a1 to a3. The short run aggregate supply curve therefore slopes upward.

Long Run

It is the period in which nominal wages are fully responsive to previous changes in the price level. Let us illustrate this by a graph. Suppose that the economy is initially at point a1 (P1 and QF). When the price level will increase from P1...

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