24.3 Shifts in Aggregate Supply
2 min read•june 24, 2024
is a key player in the economic game. It's all about how much stuff an economy can produce at different price levels. Factors like productivity, input costs, and unexpected events can make a big impact.
Imagine the economy as a factory. Productivity improvements are like upgrading the machines, while input costs are the raw materials. ? They're the curveballs that can throw everything off balance. Understanding these factors helps predict economic ups and downs.
Factors Affecting Aggregate Supply
Productivity Improvements
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- Productivity improvements increase aggregate supply
- Productivity measures output produced per unit of input
- Improvements allow more output with same inputs
- Productivity improvements result from:
- (automation, software)
- Improved worker skills and education (training, higher education)
- Better management practices (lean manufacturing, Six Sigma)
- Productivity increases shift aggregate supply curve to the right
- At every price level, greater quantity of goods and services supplied
- Rightward shift of aggregate supply curve leads to:
- Increase in real GDP ()
- Decrease in price level, assuming constant aggregate demand (lower inflation)
Input Costs
- Changes in input costs shift aggregate supply curve
- Increase in input costs shifts aggregate supply curve left
- Input costs include:
- Wages paid to workers (labor costs)
- Prices of raw materials (commodities, components)
- Energy costs (electricity, fuel)
- Higher input costs increase production costs for firms
- At each price level, firms supply smaller quantity of goods and services
- Input costs include:
- Decrease in input costs shifts aggregate supply curve right
- Lower input costs reduce production costs for firms
- At each price level, firms supply larger quantity of goods and services
- Direction of shift depends on change in input costs
- Rising costs shift curve left ()
- Falling costs shift curve right (cost savings, lower prices)
Supply Shocks
- Supply shocks are unexpected events significantly affecting economy's production
- Pandemics like COVID-19 cause negative supply shocks
- Pandemics disrupt production and supply chains (factory closures, transportation delays)
- Lockdowns and social distancing reduce labor availability (remote work, layoffs)
- Businesses may close temporarily or permanently (bankruptcies, lost capacity)
- Negative supply shocks shift aggregate supply curve left
- At each price level, smaller quantity of goods and services supplied
- Leftward shift of aggregate supply curve leads to:
- Decrease in real GDP (economic contraction, recession)
- Increase in price level, assuming constant aggregate demand (cost-push inflation)
- Severity and duration of shock determine magnitude of shift
- More severe and prolonged shocks cause larger leftward shift (deeper recession, higher inflation)
- Policymakers may implement measures to mitigate impact
- (government spending, tax cuts) supports businesses and households
- (lower interest rates) stimulates economic activity (investment, consumption)
Key Terms to Review (23)
Aggregate Supply: Aggregate supply refers to the total quantity of goods and services that firms in an economy are willing and able to sell at various price levels during a given time period. It represents the supply-side of the economy and is a crucial component in understanding macroeconomic dynamics and the determination of national output, employment, and the price level.
Business Cycle: The business cycle refers to the fluctuations in economic activity over time, characterized by periods of expansion, peak, contraction, and trough. This cyclical pattern is a fundamental feature of market economies and has important implications for tracking real GDP, understanding demand and supply dynamics, and evaluating the effectiveness of macroeconomic policies.
Cost-Push Inflation: Cost-push inflation is a type of inflation caused by increases in the costs of production or the factors of production, leading to a rise in the general price level across the economy. This contrasts with demand-pull inflation, which is driven by an increase in aggregate demand.
Deflation: Deflation is a sustained decrease in the general price level of goods and services in an economy over time. It is the opposite of inflation, which is a sustained increase in the general price level. Deflation can have significant impacts on various economic topics, including adjusting nominal values to real values, tracking inflation, measuring changes in the cost of living, how countries experience inflation, and shifts in aggregate supply.
Economic Growth: Economic growth refers to the sustained increase in the productive capacity of an economy over time, resulting in a rise in the real gross domestic product (GDP) per capita. It is a fundamental concept in macroeconomics that encompasses the expansion of a country's output, employment, and standard of living.
Expansionary: Expansionary refers to economic policies and actions that are intended to stimulate or grow the economy. This term is particularly relevant in the context of shifts in aggregate supply, as expansionary measures can lead to changes in the overall production capacity and output of an economy.
Fiscal Policy: Fiscal policy refers to the use of government spending, taxation, and borrowing to influence the economy. It is a macroeconomic tool that policymakers employ to promote economic growth, stabilize the business cycle, and achieve other economic objectives.
Human Capital: Human capital refers to the knowledge, skills, and abilities that individuals possess, which contribute to their productivity and economic value. It encompasses the investments made in education, training, and health that enhance a person's capacity to work and earn. This concept is central to understanding labor markets, economic growth, and inequality across countries and individuals.
Input Prices: Input prices refer to the costs of the various resources or factors of production used by a firm or industry to produce goods and services. These input costs, such as labor, raw materials, and capital, are crucial determinants of a firm's overall production costs and, consequently, the equilibrium price and quantity in a market.
Labor Market: The labor market refers to the supply and demand for labor, in which employers seek workers and workers seek employment. It is the marketplace where the factors of production, labor and human capital, are bought and sold. The labor market is a crucial component in the overall economy, as it determines employment levels, wages, and the allocation of human resources.
Laissez-Faire: Laissez-faire is an economic policy that advocates for minimal government intervention and regulation in the economy, allowing market forces to operate with little to no interference. This principle is often associated with the concept of aggregate supply shifts in macroeconomic theory.
LRAS Curve: The LRAS (Long-Run Aggregate Supply) curve represents the relationship between the price level and the quantity of output supplied in the long run, when all factors of production can be adjusted. It depicts the economy's productive capacity and shows the maximum level of real GDP that can be produced at each price level.
Monetary Policy: Monetary policy refers to the actions taken by a country's central bank to control the money supply and influence economic conditions. It is a crucial tool used by governments to achieve macroeconomic objectives such as price stability, full employment, and economic growth.
Permanent: Permanent refers to something that is long-lasting, enduring, or intended to exist or continue indefinitely without significant change. In the context of shifts in aggregate supply, the term 'permanent' is used to describe changes that have a lasting impact on an economy's productive capacity and potential output.
Potential GDP: Potential GDP, also known as the full-employment level of GDP, represents the maximum sustainable output that an economy can produce when all of its resources, including labor, capital, and technology, are being utilized at their full capacity. It is the level of real GDP that an economy would produce if the unemployment rate was at its natural rate.
Production Capacity: Production capacity refers to the maximum level of output a business or industry can achieve given its current resources, equipment, and workforce. It represents the upper limit of an entity's ability to produce goods or services within a specific time frame and under normal operating conditions.
Productivity Growth: Productivity growth refers to the increase in the amount of output produced per unit of input, such as labor or capital. It is a crucial driver of economic growth and improvements in living standards over time. Productivity growth is central to understanding the components of economic growth, economic convergence, shifts in aggregate supply, and the relationship between fiscal policy, investment, and economic growth.
Resource Allocation: Resource allocation refers to the process of distributing and managing limited resources, such as money, time, or materials, among competing needs or demands. It involves making decisions about how to best utilize available resources to achieve desired outcomes or objectives.
SRAS Curve: The Short-Run Aggregate Supply (SRAS) curve represents the relationship between the price level and the quantity of real output supplied by producers in the short-run. It depicts how changes in the price level affect the willingness and ability of firms to supply goods and services in the economy.
Stagflation: Stagflation is a situation where there is slow economic growth, high unemployment, and high inflation all occurring at the same time. It is a challenging economic condition that combines the problems of stagnation (low growth and high unemployment) and inflation.
Supply Shocks: Supply shocks are sudden and unexpected changes in the supply of a good or service that can significantly impact the overall economy. These shocks can lead to shifts in aggregate supply, affect economic growth and unemployment, and influence the relationship between inflation and the labor market as described in the Phillips Curve.
Technological Advancements: Technological advancements refer to the improvements and innovations in technology that enhance productivity, efficiency, and overall economic output. These developments can lead to changes in production methods, create new products, and alter the way businesses operate, impacting everything from individual firms to the broader economy.
Transitory: Transitory refers to something that is temporary, short-lived, or passing in nature. It describes a state or condition that is not permanent or enduring, but rather fleeting or transitional.