Macroeconomics

nomic Review 63 ( June 1973): 326–334.

5

Laurence Ball, N. Gregory Mankiw, and David Romer, “The New Keynesian Economics and the

Output-Inflation Tradeoff,” Brookings Papers on Economic Activity 1(1988): 1–65.

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Note that the sticky-price model can also explain Lucas’s finding that coun-

tries with variable aggregate demand have steep aggregate supply curves. If the

price level is highly variable, few firms will commit to prices in advance (s will

be small). Hence, the aggregate supply curve will be steep (

a

will be small). 

■

Implications

We have seen two models of aggregate supply and the market imperfection that

each uses to explain why the short-run aggregate supply curve is upward slop-

ing. One model assumes the prices of some goods are sticky; the second assumes

information about prices is imperfect. Keep in mind that these models are not

incompatible with one another. We need not accept one model and reject the

other. The world may contain both of these market imperfections, as well as

some others, and all of them may contribute to the behavior of short-run aggre-

gate supply.

The two models of aggregate supply differ in their assumptions and emphases,

but their implications for aggregate output are similar. Both can be summarized

by the equation

Y

= Y− +

a

(P

− EP).

This equation states that deviations of output from the natural level are relat-

ed to deviations of the price level from the expected price level. If the price

level is higher than the expected price level, output exceeds its natural level. If the price

level is lower than the expected price level, output falls short of its natural level. Fig-

ure 13-1 graphs this equation. Notice that the short-run aggregate supply

curve is drawn for a given expectation EP and that a change in EP would shift

the curve.

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P A R T   I V

Business Cycle Theory: The Economy in the Short Run