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By the end of this section, you will be able to:
  • Explain how productivity growth changes the aggregate supply curve
  • Explain how changes in input prices changes the aggregate supply curve

The original equilibrium in the AD/AS diagram will shift to a new equilibrium if the AS or AD curve shifts. When the aggregate supply curve shifts to the right, then at every price level, a greater quantity of real GDP is produced. When the SRAS curve shifts to the left, then at every price level, a lower quantity of real GDP is produced. This module discusses two of the most important factors that can lead to shifts in the AS curve: productivity growth and input prices.

How productivity growth shifts the as curve

In the long run, the most important factor shifting the AS curve is productivity growth . Productivity means how much output can be produced with a given quantity of labor. One measure of this is output per worker or GDP per capita    . Over time, productivity grows so that the same quantity of labor can produce more output. Historically, the real growth in GDP per capita in an advanced economy like the United States has averaged about 2% to 3% per year, but productivity growth has been faster during certain extended periods like the 1960s and the late 1990s through the early 2000s, or slower during periods like the 1970s. A higher level of productivity shifts the AS curve to the right, because with improved productivity, firms can produce a greater quantity of output at every price level. [link] (a) shows an outward shift in productivity over two time periods. The AS curve shifts out from SRAS 0 to SRAS 1 to SRAS 2 , reflecting the rise in potential GDP in this economy, and the equilibrium shifts from E 0 to E 1 to E 2 .

Shifts in aggregate supply

The two graphs show how aggregate supply can shift and how these shifts affect points of equilibrium. The graph on the left shows how productivity increases will shift aggregate supply to the right. The graph on the right shows how higher prices for key inputs will shift aggregate supply to the left.
(a) The rise in productivity causes the SRAS curve to shift to the right. The original equilibrium E 0 is at the intersection of AD and SRAS 0 . When SRAS shifts right, then the new equilibrium E 1 is at the intersection of AD and SRAS 1 , and then yet another equilibrium, E 2 , is at the intersection of AD and SRAS 2 . Shifts in SRAS to the right, lead to a greater level of output and to downward pressure on the price level. (b) A higher price for inputs means that at any given price level for outputs, a lower quantity will be produced so aggregate supply will shift to the left from SRAS 0 to AS 1 . The new equilibrium, E 1 , has a reduced quantity of output and a higher price level than the original equilibrium (E 0 ).

A shift in the SRAS curve to the right will result in a greater real GDP and downward pressure on the price level, if aggregate demand remains unchanged. However, if this shift in SRAS results from gains in productivity growth, which are typically measured in terms of a few percentage points per year, the effect will be relatively small over a few months or even a couple of years.

How changes in input prices shift the as curve

Higher prices for inputs that are widely used across the entire economy can have a macroeconomic impact on aggregate supply. Examples of such widely used inputs include wages and energy products. Increases in the price of such inputs will cause the SRAS curve to shift to the left, which means that at each given price level for outputs, a higher price for inputs will discourage production because it will reduce the possibilities for earning profits. [link] (b) shows the aggregate supply curve shifting to the left, from SRAS 0 to SRAS 1 , causing the equilibrium to move from E 0 to E 1 . The movement from the original equilibrium of E 0 to the new equilibrium of E 1 will bring a nasty set of effects: reduced GDP or recession, higher unemployment because the economy is now further away from potential GDP, and an inflationary higher price level as well. For example, the U.S. economy experienced recessions in 1974–1975, 1980–1982, 1990–91, 2001, and 2007–2009 that were each preceded or accompanied by a rise in the key input of oil prices. In the 1970s, this pattern of a shift to the left in SRAS leading to a stagnant economy with high unemployment and inflation was nicknamed stagflation    .

Conversely, a decline in the price of a key input like oil will shift the SRAS curve to the right, providing an incentive for more to be produced at every given price level for outputs. From 1985 to 1986, for example, the average price of crude oil fell by almost half, from $24 a barrel to $12 a barrel. Similarly, from 1997 to 1998, the price of a barrel of crude oil dropped from $17 per barrel to $11 per barrel. In both cases, the plummeting price of oil led to a situation like that presented earlier in [link] (a), where the outward shift of SRAS to the right allowed the economy to expand, unemployment to fall, and inflation to decline.

Along with energy prices, two other key inputs that may shift the SRAS curve are the cost of labor, or wages, and the cost of imported goods that are used as inputs for other products. In these cases as well, the lesson is that lower prices for inputs cause SRAS to shift to the right, while higher prices cause it to shift back to the left.

Other supply shocks

The aggregate supply curve can also shift due to shocks to input goods or labor. For example, an unexpected early freeze could destroy a large number of agricultural crops, a shock that would shift the AS curve to the left since there would be fewer agricultural products available at any given price.

Similarly, shocks to the labor market can affect aggregate supply. An extreme example might be an overseas war that required a large number of workers to cease their ordinary production in order to go fight for their country. In this case, aggregate supply would shift to the left because there would be fewer workers available to produce goods at any given price.

Key concepts and summary

The aggregate demand/aggregate supply (AD/AS) diagram shows how AD and AS interact. The intersection of the AD and AS curves shows the equilibrium output and price level in the economy. Movements of either AS or AD will result in a different equilibrium output and price level. The aggregate supply curve will shift out to the right as productivity increases. It will shift back to the left as the price of key inputs rises, and will shift out to the right if the price of key inputs falls. If the AS curve shifts back to the left, the combination of lower output, higher unemployment, and higher inflation, called stagflation, occurs. If AS shifts out to the right, a combination of lower inflation, higher output, and lower unemployment is possible.

Questions & Answers

accounts in balance of trade
Kamuyu Reply
What is fiscal policy and intrest rates
Attah Reply
income and expenditure
Bittu Reply
Macro economics : it is the study of all aggregate of all economic activities of an economic as whole.
Rajat Reply
what is macro economics
Sarah Reply
it is study of all aggregate of all economic activities of an economic as whole.
Rajat
Macro economics is the aggregate study of national income, investment, price level, changes in economic activities, GDP and economic inflation.
Zahid
hey
Ahmed
how are you
Ahmed
thanks
Ahmed
i am find
Ahmed
what about you
Ahmed
am good bro
Ahmed
am fine
Ahmed
what is comparative and superlative advantage? give an example
Xanaan Reply
Methods used to correct trade deficits?
David Reply
what is role capitalism unemployment?
Mafsuud Reply
being unemployment look job but not achieved their being out labor force is person can't work
Mafsuud
being unemployment look job but not achieved their being out labor force is person can't work
Mafsuud
themes studied in economics include?
Patrick Reply
Financial accounting GDP and GNP
Samson Reply
can u explain
Sarah
this means that the demand curve have negative relationship with the price ..which means that when high price low demand of the product and vice versa so higher price will shirnk the demand of product
Ahsan Reply
Higher price level ∴Real value of household wealth increase ∴Net export decrease ∴More money needed, interest rate increase, investment decrease
sirius
net export decrease
Cyril
a person has 60birr to buy two commodities,x and y the price of x is four birr unit the price of y is two birr unit his utility functio given by u=xy+2x determine the budget equation
Mohammed Reply
the budget equation will be- 60 birr= 4x+2y
Ramu
What are the various reasons for the Federal Reserve to increase the fed rates?
AMEEN Reply
What is unemployment
Mijash Reply
Unemployment is a term used to describe people who do not hold a paying job
JASON
what are the causes of unemployment
evans
unemployment refer to the situation in which people searching job but they have no. it also refers in which marginal productivity in zero.
Ramu
Causes of unemployment are: 1: Over Population 2: Break down of the family system 3: Rural/Urban Migration
Umar
unemployment simply means, in the situation where by people are looking for a job and their could achieve it.
Faruk
unemployment is a situation where by one has the ability to work but is not given a job
Sarah
suppose you're the economist of ethiopia; when the country is face high rate of inflation what you recommend as one economist?
Roba Reply
if consumer spend all their incomes on consumption what does it mean?
Roba
if the government spends more of its revenue on development infrastructure from the budget it have and lower tax collection the budget deficit will run why?
Roba
because tax is less than revenue
Bhat

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Source:  OpenStax, Macroeconomics. OpenStax CNX. Jun 16, 2014 Download for free at http://legacy.cnx.org/content/col11626/1.10
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