Question

Explain the factors that cause changes (shifts) in AS?

Answer 1

The answer to this question will differ depending on whether change in supply happens in long run or short run.

Aggregate supply refers to the quantity supplied of all goods and services ( Real GDP) at various price levels, Ceteris paribus.Aggregate supply includes Short run aggregate supply and long run aggregate supply.

* Factors that result in changes in long run aggregate supply.

> Economy's production capacity

Changes that will increase the economy's productive capacity will result in an increase in aggregate supply or shift the long run aggregate supply curve to right and a decline in productive capacity would shift the long run aggregate supply curve to left.

* Expansion in the supply of physical capital and natural resources and labour would result in a rise in the economy's productive capacity. On the other hand, reduction in physical capital over time would lead to a fall in the production capacity of an economy.

* physical capital investment expands the supply of buildings, machines and other physical assets . Education and training improve the quality of life of labour force and their by expand the human capital. Investment in human capital enhances output both now and in the future.

* Improvements in technology- the discovery of economical new products or less costly ways of producing goods and services also enables us to squeeze a larger output from given resource supply.

* Finally, institutional changes can also increase long run aggregate supply if they succeed in enhancing economic efficiency and productivity.

> Factors that cause shifts in long run aggregate supply

* Wage rate.

Higher wage rates mean higher costs and, at constant prices , translate into lower profits and a reduction in the number of units of a good that a firm would want to producing resulting in a fall in short run aggregate supply. On the other hand, lower wage rates would lead to a rise in short run aggregate supply.

* prices of non labour inputs

There are a other inputs to production beyond labour. Changes in their prices affect the SRAS curve same way changes in wage rates do.

* productivity

Productivity describes the output produced per unit of input employed over some period of time. Let's consider labour input . An increase in labour productivity means businesses would produce more output with the same amount of labour. This would cause an increase in short run aggregate supply.

A decrease in the labour productivity means that businesses would produce less amount of output with the same amount of labour. Result would be a reduction in short run aggregate supply.

* Supply shocks

Major natural or institutional changes on the supply side of the economy that affect aggregate supply are referred to as supply shocks.Bad weather that wipes out a large part of what or rice crop would be considered a supply shock. So would be a major cut back in the supply of oil coming to US from Middle East.

Supply shocks are of two varieties. Adverse supply shocks like the above mentioned ones shift the short run aggregate supply curve left ward. On the other hand, beneficial supply shocks shift it right ward. Examples of beneficial supply shocks include a major oil discovery and unusually good weather leading to an increased production of food crops. These supply shocks are reflected in resource or input prices.