Explain how flexible wages, input prices, and inflation expectations move SRAS after a shock, restoring full employment and the natural rate of unemployment.
The economies of Country L and Country A are currently in short-run equilibrium at output levels below full employment. Both countries intend to use monetary policy to close their output gaps. Country L has a banking system with limited reserves, and Country A has a banking system with ample reserves.
Assume instead that no policy actions are taken in Country A and that the economy remains in short-run equilibrium at an output level below full employment. Will short-run aggregate supply in Country A increase, decrease, or remain the same as the economy self-adjusts in the long run? Explain.
Short-run aggregate supply will increase until it reaches full employment. The increase in short-run aggregate supply in the long run will be caused by a decrease in input prices (e.g., nominal wages) and/or inflationary expectations.