Decrease in Aggregate Supply

Definition

A decrease in aggregate supply refers to a situation where the total production of goods and services in an economy falls, leading to a leftward shift in the short-run aggregate supply curve. This reduction can result from factors such as rising production costs, supply chain disruptions, or negative external shocks, causing a higher price level and lower output. When aggregate supply decreases, it can lead to inflationary pressures and economic slowdowns, impacting overall economic stability.

5 Must Know Facts For Your Next Test

1. A decrease in aggregate supply is often represented by a leftward shift of the SRAS curve on a graph, indicating reduced output at all price levels.
2. Common causes of a decrease in aggregate supply include increased production costs due to higher wages, rising prices for raw materials, and adverse weather conditions affecting agriculture.
3. When aggregate supply decreases while aggregate demand remains constant, the result is typically higher prices and lower quantities of goods and services produced.
4. The concept of cost-push inflation is closely linked to decreases in aggregate supply, where rising costs lead firms to pass those costs onto consumers through higher prices.
5. Policy responses to a decrease in aggregate supply may include government interventions or adjustments in monetary policy to stabilize the economy.

Review Questions

• How does a decrease in aggregate supply affect the overall economy's output and price level?
  • A decrease in aggregate supply leads to a leftward shift of the SRAS curve, resulting in higher price levels and lower output. This means that consumers face higher prices for goods and services while businesses produce less than before. The combination of these factors can create inflationary pressures, making it more challenging for consumers and businesses alike to navigate the economic landscape.
• Discuss how external shocks can lead to a decrease in aggregate supply and provide examples.
  • External shocks, such as natural disasters, geopolitical conflicts, or significant increases in oil prices, can disrupt production processes and lead to a decrease in aggregate supply. For example, if a hurricane damages infrastructure necessary for transportation and production, companies may struggle to source materials or deliver finished goods. This disruption results in reduced overall output while costs may rise due to scarcity, ultimately shifting the SRAS curve to the left.
• Evaluate the implications of a sustained decrease in aggregate supply on long-term economic growth and stability.
  • A sustained decrease in aggregate supply can have severe implications for long-term economic growth and stability. Prolonged reductions in output can lead to increased unemployment rates as firms scale back production or shut down operations entirely. Additionally, persistent inflationary pressures can erode purchasing power and consumer confidence. If not addressed through appropriate policy measures, these conditions could result in a stagnant economy characterized by slow growth, increased poverty levels, and heightened social unrest.

Related terms

Aggregate Demand: The total demand for all goods and services in an economy at a given overall price level and in a given time period.

Short-Run Aggregate Supply (SRAS): The short-run aggregate supply curve shows the relationship between the price level and the quantity of goods and services that firms are willing to produce at that price level, holding some input prices constant.

Cost-Push Inflation: A type of inflation that occurs when the overall price levels rise due to increases in the cost of wages and raw materials, leading to a decrease in aggregate supply.