Why will the price level tend to rise as firms get closer to their productive capacity?...

Why will the price level tend to rise as firms get closer to their productive capacity? Would expansionary fiscal and monetary policy be beneficial on the vertical portion?

Expert Solution

As there is increased production in the short run aggregate supply is considered to be flat for a considerable level of output because there is an excess capacity of production which does not create upward pressure on the cost of production. Due to this reason firms can supply any amount of output at the same market price. However as the productive capacity is reached, resource cost increases and this put an upward pressure on the minimum price that firms are willing to charge. This implies that as the productive capacity is exhausted, increased production requires increased price level because of increasing cost. The aggregate supply curve slopes up near its productive capacity

expansionary fiscal and monetary policy are not helpful in the vertical portion of the aggregate supply curve. Economy operates at its productive capacity when aggregate supply curve is vertical. This implies that any increase in the price is not going to influence the production because it is already maximized.

Rahul Sunny answered 9 months ago

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