Question

1. Discuss, with examples, factors or events that might shift the short run aggregate supply curve.

2. Imagine an economy is in long run equilibrium. Now suppose that firms experience an increase in their cost of production (ex: due to a natural disaster).

3. Explain, with graphs, the macroeconomic impact of such an increase in production costs and Describe how policymakers could use fiscal policy to counteract the effects of increased cost of production.

Answer 1

Factors that shift supply curve are:

• Change in cost of production
• Change in wage rate
• Number of sellers
• Technical advancement

If there is increase in cost of production, it will reduce the profit of producers which will induce to produce less of the goods and shift aggregate supply curve to its left from AS to AS1 while demand remains the same. It will result in rise in price from P to P1 and output to fall from Y to Y1.

Government can adopt expansionary fiscal policy which will raise government spending and reduce tax such that it raise aggregate demand in the economy and shift its curve to the right which will raise price further and take output to its initial level of Y.