What Causes Aggregate Supply to Shift

11 Key excerpts on "What Causes Aggregate Supply to Shift"

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  eBook - PDF

  Macroeconomics

  A Contemporary Introduction

  • William A. McEachern(Author)
  • 2016(Publication Date)
  • Cengage Learning EMEA

    (Publisher)

  Shifts of the aggregate demand curve change the price level but do not affect potential output, or long-run aggregate supply. C H E C K P O I N T Why do shifts of the aggregate demand curve change the price level in the long run but not potential output? Copyright 2017 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. Chapter 10 Aggregate Supply 227 10-4 Changes in Aggregate Supply In this section, we consider factors other than changes in the expected price level that may affect aggregate supply. We begin by distinguishing between long-term trends in aggregate supply and supply shocks, which are unexpected events that affect aggregate supply, sometimes only temporarily. 10-4a What If Aggregate Supply Increases? The economy’s potential output is based on the willingness and ability of households to supply resources to firms, the level of technology and know-how, and the institu- tional underpinnings of the economic system. Any change in these factors could affect the economy’s potential output. Changes in the economy’s potential output over time were introduced in the earlier chapter that focused on U.S. productivity and growth. The supply of labor may change over time because of a change in the size, composition, or quality of the labor force or a change in preferences for labor versus leisure. For ex- ample, the U.S. labor force has more than doubled since 1948 as a result of population growth and a growing labor force participation rate, especially among women with children. At the same time, job training, education, and on-the-job experience increased the quality of labor.

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  Economics

  A Contemporary Introduction

  • William A. McEachern(Author)
  • 2016(Publication Date)
  • Cengage Learning EMEA

    (Publisher)

  Shifts of the aggregate demand curve change the price level but do not affect potential output, or long-run aggregate supply. C H E C K P O I N T Why do shifts of the aggregate demand curve change the price level in the long run but not potential output? Copyright 2017 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. Chapter 24 Aggregate Supply 559 24-4 Changes in Aggregate Supply In this section, we consider factors other than changes in the expected price level that may affect aggregate supply. We begin by distinguishing between long-term trends in aggregate supply and supply shocks, which are unexpected events that affect aggregate supply, sometimes only temporarily. 24-4a What If Aggregate Supply Increases? The economy’s potential output is based on the willingness and ability of households to supply resources to firms, the level of technology and know-how, and the institu- tional underpinnings of the economic system. Any change in these factors could affect the economy’s potential output. Changes in the economy’s potential output over time were introduced in the earlier chapter that focused on U.S. productivity and growth. The supply of labor may change over time because of a change in the size, composition, or quality of the labor force or a change in preferences for labor versus leisure. For ex- ample, the U.S. labor force has more than doubled since 1948 as a result of population growth and a growing labor force participation rate, especially among women with children. At the same time, job training, education, and on-the-job experience increased the quality of labor.

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  Macroeconomics

  • William Boyes, Michael Melvin(Authors)
  • 2015(Publication Date)
  • Cengage Learning EMEA

    (Publisher)

  These effects explain movements along a given AD curve. 4. The aggregate demand curve shifts with changes in the nonprice determinants of aggregate demand: expectations, foreign income and price levels, and government policy. 3. What factors affect aggregate supply? 158 Chapter 8 Macroeconomic Equilibrium: Aggregate Demand and Supply Copyright 2016 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. 8-4b-1 Short-Run Aggregate Supply Curve Figure 9 represents the general shape of the short-run aggregate supply curve. In Figure 10, you see a more realistic version of the same curve—its steepness varies. The steepness of the aggregate supply curve depends on the ability and willingness of producers to respond to price-level changes in the short run. Figure 10 shows the typical shape of the short-run aggregate supply curve. Notice that as the level of real GDP increases in Figure 10, the AS curve becomes steeper. This is because each increase in output requires firms to hire more and more resources, until eventually full capacity is reached in some areas of the economy, resources are fully employed, and some firms reach maximum output. At this point, increases in the price level bring about smaller and smaller increases in output from firms as a whole. The short-run aggregate supply curve becomes increasingly steep as the economy approaches maximum output. 8-4b-2 Long-Run Aggregate Supply Curve Aggregate supply in the short run is dif-ferent from aggregate supply in the long run (see Figure 11).

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  Macroeconomics

  Principles and Policy

  • William Baumol, Alan Blinder(Authors)
  • 2015(Publication Date)
  • Cengage Learning EMEA

    (Publisher)

  This chapter took the next step by showing how shifts in the aggregate demand curve cause fluctuations in both real GDP and prices—fluctuations that are widely decried as undesirable. It also sug-gested that the economy’s self-correcting mechanism works, but slowly, thereby leaving room for government stabilization policy to improve the workings of the free market. Can the government really accomplish this goal? If so, how? These are some of the important questions for Part 3. Copyright 2016 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. Chapter 10 Bringing in the Supply Side: Unemployment and Inflation? 211 1. The economy’s aggregate supply curve relates the quantity of goods and services that will be supplied to the price level. It normally slopes upward to the right because the costs of labor and other inputs remain relatively fixed in the short run, meaning that higher selling prices make input costs relatively cheaper and therefore encourage greater production. 2. The position of the aggregate supply curve can be shifted by changes in money wage rates, prices of other inputs, technology, or quantities or qualities of labor and capital. 3. The equilibrium price level and the equilibrium level of real GDP are jointly determined by the intersec-tion of the economy’s aggregate supply and aggregate demand schedules. 4. Among the reasons why the oversimplified multiplier formula is wrong is the fact that it ignores the inflation that is caused by an increase in aggregate demand. Such inflation decreases the multiplier by reducing both consumer spending and net exports.

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  Macroeconomics for Business

  The Manager's Way of Understanding the Global Economy

  • Lawrence S. Davidson, Andreas Hauskrecht, Jürgen von Hagen(Authors)
  • 2020(Publication Date)
  • Cambridge University Press

    (Publisher)

  3 Aggregate Supply and Short-Run Equilibrium Macroeconomic policy debates tend to focus on aggregate demand. When output is considered too low or unemployment is rising, policymakers, the media, and the public call on the Fed to cut interest rates or on the federal government to provide stimulus. When inflation is going up, the Fed is told to put it under control. We want fast solutions and the way to get them is by managing aggregate demand. Therefore, most of this book is devoted to aggregate demand. But aggregate demand is not the whole story. Sometimes, households and busi- nesses do not respond to low interest rates or fiscal stimulus in the way the Fed or the government would like, or their response is weak and slow. Furthermore, focusing on aggregate demand does not help when the economy is faced with changes in cost conditions such as energy or raw materials prices. And, finally, the government may try to increase aggregate demand and GDP by increasing government spending. But if this spending is financed by a rise in, say, income taxes, the government may see that people work less, because they get to keep less of an hour’s wage. Real GDP may then rise less than hoped for and the fiscal stimulus primarily results in higher prices. Focusing on aggregate demand is also not helpful if we want to explain a country’s level and growth of potential output, or its longer-term economic trend and standard of living. Adding aggregate supply to our understanding of aggregate demand allows for a complete approach to macroeconomic change and policy. Now we turn to the supply side of the economy. This chapter introduces you to the determinants of aggregate supply. It is all about the quantity of goods and services the economy produces given its stock of productive capital, its stock of technological knowledge, and its labor force. In this chapter, we focus on short-run aggregate supply. Long-term developments of aggregate supply will be discussed in Chapters 6 and 7.

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  Economics

  The Definitive Encyclopedia from Theory to Practice [4 volumes]

  • David A. Dieterle(Author)
  • 2017(Publication Date)
  • Greenwood

    (Publisher)

  A AGGREGATE DEMAND AND AGGREGATE SUPPLY

  Aggregate demand and aggregate supply are two of the primary concepts in macroeconomics. Aggregate means total, and demand is the desire and ability to purchase goods and services. Supply refers to the desire and ability of producers to provide goods and services. Aggregate demand is the total amount of goods and services demanded in an economy during a given time period, while aggregate supply is the total amount of goods and services provided. Aggregate demand is composed of all consumer spending, investment spending, government spending, and net exports (exports–imports)—the components of gross domestic product (GDP). Aggregate supply is composed of all income, in the forms of wages, rents, profits, and interest earned.

  The British economist John Maynard Keynes (1883–1946) is credited with creating the concepts of aggregate demand and aggregate supply. He used these concepts in the 1930s to explain how governments can recover from recessions by increasing government spending to impact aggregate demand, which in turn would increase aggregate supply. Keynes did the lion’s share of his writing and economic thought from 1920 to 1940. Prior to Keynes, market explanations centered on classical economics, popularized by the writings of Adam Smith (1723–1790). Smith emphasized the market concept of laissez faire, which is the minimal use of government actions to control economic activity.

  Aggregate demand and aggregate supply are graphed on the aggregate demand and aggregate supply graph with the y-axis being the general price level, or CPI, and the x-axis being real GDP. The aggregate demand curve is downward-sloping to the right while the aggregate supply curve is upward-sloping.

  Aggregate Demand

  Most economists support the downward-sloping aggregate demand (AD) curve for three primary reasons: the wealth effect, the interest rate effect, and the exchange rate effect. All three of the explanations for the downward-sloping AD curve center around lower prices, which induce greater quantity demanded and the downward slope of the AD curve. When the price level falls, wages do not change immediately, which makes consumers feel wealthier so they purchase more goods and services than before. When interest rates fall, consumer spending on durable goods such as homes and cars and business investments on capital goods will increase. When the domestic exchange rate falls, domestic exports become relatively cheaper to foreign consumers and foreign sales will increase.

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  Principles of Macroeconomics 3e

  • David Shapiro, Daniel MacDonald, Steven A. Greenlaw(Authors)
  • 2022(Publication Date)
  • Openstax

    (Publisher)

  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, SRAS and LRAS would both shift to the left because there would be fewer workers available to produce goods at any given price. Another example in this vein is a pandemic, like the COVID-19 pandemic. A pandemic causes many workers to become sick, temporarily reducing the supply of workers by a large amount. Further, workers might be cautious to go back to work in a pandemic because of health or safety concerns. While the shock to labor supply might not be permanent, it can cause a reduction in the supply of many goods and services, reflected in a leftward shift in the short-run aggregate supply curve. At various points during the COVID-19-induced pandemic, computer chips for automobiles, meat, and other consumer services were in short supply because of worker shortages around the world. 11.4 Shifts in Aggregate Demand LEARNING OBJECTIVES By the end of this section, you will be able to: • Explain how imports influence aggregate demand • Identify ways in which business confidence and consumer confidence can affect aggregate demand • Explain how government policy can change aggregate demand • Evaluate why economists disagree on the topic of tax cuts As we mentioned previously, the components of aggregate demand are consumption spending (C), investment spending (I), government spending (G), and spending on exports (X) minus imports (M). (Read the following Clear It Up feature for explanation of why imports are subtracted from exports and what this means for aggregate demand.) A shift of the AD curve to the right means that at least one of these components increased so that a greater amount of total spending would occur at every price level.

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  Foundations of Macroeconomics

  Its Theory and Policy

  • Frederick S. Brooman(Author)
  • 2017(Publication Date)
  • Routledge

    (Publisher)

  3. Variations in Price and Money Wages

  The intersection of the aggregate supply and demand curves indicates both the equilibrium level of physical output and (given the constant money wage w̄) the equilibrium level of prices. If an autonomous change in “real” demand occurs, it will shift the aggregate demand curve to intersect the aggregate supply curve at a new equilibrium position. Thus, in Figure 10.3 , an increase in real investment will raise the aggregate demand curve from d1 (Q,p) to d2 (Q,p); equilibrium moves from E1 to E2 , output rises from Q1 to Q2 , and prices increase from the level indicated by the slope of p1 to that indicated by the slope of p2 . As long as firms continue to offer their output at its supply price (i.e., w̄) MPL), their response to the increase in demand will be to attempt to produce more commodities and to raise their selling prices only when the expansion of output and employment reduces the marginal product of labor, making price increases necessary to meet the rising value of ‘w̄/MPL. The transition from the old equilibrium at E1 to the new one at E2 will then take the form of an upward movement along the aggregate supply curve.

  However, firms may react in a different way. Faced with excess demand equal to E1 T in money terms, they may begin by raising prices to the level that buyers seem willing to pay – namely, the price level p3 . The price rise will immediately create an incentive for firms to increase production, since the excess of price over marginal labor cost w̄/MPL shows that they will add to their profits if they hire more labor and expand output; but before the expansion can get under way, the situation may be made more complicated by the effects of the price increase on aggregate demand. If the “real” relationship between income and demand remains unchanged, the amount of money that buyers wish to spend will rise in the same proportion as the price level, and in money terms the excess demand will be still larger than before.11 On the other hand, the price increase will have set the redistribution effect to work, because with money wages constant, real wages have fallen; at the original level of output Q1 , both total real wages and the “wage share” in income will be reduced in proportion to the rise in prices, causing a fall in real consumption to the extent that the wage earners’ MPC exceeds the MPC of profit recipients.12

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  Macroeconomics for Managers

  • Michael K. Evans(Author)
  • 2008(Publication Date)
  • Wiley-Blackwell

    (Publisher)

  part III Aggregate supply: inflation, unemployment, and productivity Part II of this text presented the basic elements required for the joint determination of real output and real interest rates using the components of aggregate demand. In deriving the IS/LM diagram, prices were held constant, yet the increase in inflation when demand outstrips supply is one of the key issues in macroeconomics. However, this element cannot be adequately discussed without a more complete explanation of aggregate supply. Hence part III presents the determinants of the major elements of the supply side of the economy: inflation, wage rates, unemployment, and productivity. It starts with a detailed treatment of inflation, since the assumption that prices do not change is clearly unrealistic. Chapter 8 covers the determinants of inflation, which are based largely on expectations about how economic agents – both business and labor – think prices will change in the future. In the long run, inflation is primarily a monetary factor. In the short run, changes in the rate of inflation are tied to changes in unit labor costs, particularly wage rates. Inflation is also determined by institutional factors that influence wage rates, government regulations affecting domestic and international competitive practices, productivity growth, supply shocks, and changes in the value of the currency. Chapter 9 explains several possible reasons why high unemployment often persists even in the long run. Chapter 10 introduces the production function, and reviews the basic determinants of long-term productivity growth. These chapters show that while monetary policy is the principal policy factor affecting short-term fluctuations in real growth, and is a key factor in determining the rate of inflation in both the short term and the long term, fiscal policy is the primary determinant of the long-run growth rate in productivity and hence real GDP.

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  Test Bank for Introductory Economics

  And Introductory Macroeconomics and Introductory Microeconomics

  • John G. Marcis, Michael Veseth(Authors)
  • 2014(Publication Date)
  • Academic Press

    (Publisher)

  (158) a. Increase; decrease; decrease. B. Decrease; decrease; increase. c. Increase; decrease; increase. d. Decrease; increase; decrease. e. Increase; increase; decrease. 4. Suppose that we observe an intended increase in inventory levels throughout the economy. What can be concluded from the above information? (154-156) a. Aggregate supply has increased. B. Firms may expect an increase in sales shortly. c. Firms may expect that the general level of prices will fall shortly. d. Firms may expect an increase in taxes shortly. e. Aggregate supply has decreased. 5. News reports indicated that inventory levels have risen at the same time that the producer price index has decreased. Which of the follow-ing events best explains the facts presented above? (147, 160, Fig. 7-10) a. An increase in government spending occurred. b. A decrease in taxes occurred. C. An increase in oil prices occurred. d. An increase in exports occurred. e. A decrease in interest rates occurred. 6. During periods of rapid and sustained economic expansion, the economy may occasionally enter 6 2 AGGREGATE SUPPLY AND THE ECONOMY 63 the full-employment portion of the aggregate supply curve. When this occurs: (149-150) A. it is impossible to increase real gross na-tional product further. b. full employment and price stability result. c. the resulting increase in output is accom-panied by price level stability. d. it is impossible to produce more of some goods even if production of other goods is reduced. e. the resulting surpluses of labor and/or materials will lead to price reductions. 7. The presence of cost-push inflation results in both inflation and increased unemployment. If the increase in unemployment is fought by increasing the aggregate demand, the result is: (161, Fig. 7-11) a. an even greater unemployment rate. b. that an unintended reduction in inven-tories will occur.

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  A Primer on Macroeconomics

  Policies and Perspectives

  • Thomas M. Beveridge(Author)
  • 2018(Publication Date)
  • Business Expert Press

    (Publisher)

  1 , intersect, at an aggregate price level of P* and an output level of y*. However, it is worthwhile to trace through the process by which the economy achieves that equilibrium.

  To analyze the equilibrating process, let us suppose that the AD curve initially is at AD0 , and that the equilibrium price and output are P0 and y0 , respectively. Now aggregate demand increases from AD0 to AD1 . Can you think of a reason for such a shift? If not, refer back to the section on factors that can shift aggregate demand.

  At the initial aggregate price level, P0 , the quantity of goods and services supplied (y 0 ) now is less than the quantity demanded. Inventories are falling below firms’ desired levels as firms scramble to meet the unexpectedly high demand. The depletion of inventories is a signal for firms to increase their prices and to hire more workers and increase production. As the aggregate price level rises and wages and other resource costs lag behind, the economy’s output level increases. At the same time, as the aggregate price level increases, the wealth, real interest rate, and foreign trade effects are felt by consumers and firms, and there is a decline in the quantity of aggregate output demanded. (Shown as a movement along the AD curve.)

  As long as there is a mismatch between quantity demanded and quantity supplied in the economy, there will be an ongoing process to achieve equilibrium. That (short-run) equilibrium is reached at point E.

  THINK IT THROUGH: Note that the short-run equilibrium output level, y*, need not be the full-employment output level (y FE ). In our example, we have two short-run equilibria, at y 0 and y*. Clearly, even if one of these were the output level at which full employment occurs, then the other equilibrium could not be, so, in general, we cannot assume that, in the short run, the economy will achieve full employment.

  The Self-Correcting Mechanism: Harmony in the Long Run

  At this point, you may feel that there is an inconsistency in economics. On the one hand, we have just concluded that there is no guarantee that the economy will be at the full-employment output level in the short run but, on the other hand, we asserted earlier that the economy will operate on the LRAS curve, which is located precisely at that output level. In this section, we resolve this puzzle.

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