Question

There are several determinants of aggregate supply that can cause the aggregate supply curve to shift. a. Describe those determinants and give an example of a change in each. b. Draw and label an aggregate supply diagram that illustrates the effect of the change in each determinant.

Short answer

Question: Explain the key determinants of aggregate supply and give examples of changes that could lead to shifts in the curve. Additionally, describe how the aggregate supply curve shifts in response to these changes. Answer: The key determinants of aggregate supply are resource prices/input costs, technological progress, government policies, and the availability of inputs. For example, a decrease in input costs or an improvement in technology would result in an increase in aggregate supply and a rightward shift in the curve. On the other hand, increased production costs or decreased input availability would decrease aggregate supply and shift the curve to the left. Government policies, such as lower corporate taxes, could increase aggregate supply, while increased regulations could decrease it. When illustrating these shifts on a diagram, the aggregate supply curves (AS1 and AS2) would move accordingly on the graph with labeled axes.

Step-by-step solution

Part a: Determinants of Aggregate Supply and Examples of Changes

There are several key determinants of aggregate supply that can cause the aggregate supply curve to shift. Let's explain each of them and give examples of changes that could lead to shifts in the curve: 1. Resource Prices/Input Costs: If the costs of production inputs such as labor, raw materials, or capital resources decrease, aggregate supply will increase, and the curve will shift to the right. Similarly, if input costs increase, aggregate supply will decrease, resulting in the curve shifting to the left. For example, if there is a reduction in the price of oil, the cost of transporting goods could be lowered, which might lead to an increase in aggregate supply. 2. Technological Progress: Technological advancements in production methods allow for more output with the same amount of inputs or use fewer inputs to produce the same amount of output. This improvement in productivity would increase aggregate supply and shift the curve to the right. An example could be the introduction of automation in manufacturing, which allows for faster and more efficient production processes. 3. Government Policies: Government policies can either increase or decrease aggregate supply, depending on their effects on production costs, regulations, and workforce availability. For instance, a decrease in corporate tax rates might decrease companies' production costs and increase aggregate supply, shifting the curve to the right. 4. Availability of Inputs: An increase in the availability of crucial inputs such as labor or capital resources can increase aggregate supply, causing the curve to shift to the right. Conversely, a decrease in input availability would cause the aggregate supply curve to shift left. For example, an increase in immigration could cause an increase in the labor supply, potentially leading to increased production and higher aggregate supply.

Part b: Drawing Aggregate Supply Diagrams

Let's draw and describe diagrams that depict the effect of the above changes on the aggregate supply curve. 1. Resource Prices/Input Costs: If the input costs decrease, the aggregate supply curve shifts to the right. On the other hand, if input costs increase, the aggregate supply curve shifts to the left. 2. Technological Progress: When there's an improvement in technology, the aggregate supply curve shifts to the right due to increased productivity. 3. Government Policies: For example, if the government reduces corporate taxes, the aggregate supply curve shifts to the right. In contrast, increased regulations or higher taxes could potentially shift the curve to the left. 4. Availability of Inputs: An increase in the availability of crucial input resources would cause the aggregate supply curve to shift to the right, while a decrease in input resources would cause it to shift to the left. In each of these cases, the aggregate supply diagram could include a labeled axis (x-axis as Real GDP and y-axis as the Price level) with an initial aggregate supply curve (AS1) and the shifted aggregate supply curve (AS2). The illustration should show the direction of the shift in each case depending on the change in the determinant (either increasing or decreasing).

Key concepts

Resource Prices

Resource Prices refer to the cost of the inputs used in the production of goods and services. These costs include wages for labor, prices of raw materials such as oil, metals, or agricultural products, and the cost of capital like machinery or buildings. Changes in these prices can significantly influence the aggregate supply.

When resource prices decrease, the costs for producing goods and services also fall. This makes it cheaper for companies to create products, encouraging increased production. As a result, the aggregate supply curve shifts to the right, indicating higher supply levels at the same price.

• For example, a drop in oil prices reduces transportation and production costs across various industries, supporting an increase in overall supply.

Conversely, if resource prices increase, production becomes more expensive, leading to a reduction in supply. This causes the aggregate supply curve to shift left, reflecting lower production levels at a given price.

Technological Progress

Technological progress refers to advancements and improvements in production processes, which allow for more efficient outputs. These can include better machinery, production techniques, or automation. Such advancements typically enable companies to produce more goods with the same amount of resources, enhancing productivity and influencing aggregate supply positively.

When technology progresses, firms can produce goods faster and more efficiently, often with lower costs. This improvement shifts the aggregate supply curve to the right as companies can supply more products at the same price level.

• An example is the introduction of robotics in manufacturing, which speeds up production and reduces human error, boosting the overall supply without additional resource input.

Therefore, technological progress is a key driver in increasing aggregate supply, reflecting economic growth and enhanced production capacity.

Government Policies

Government policies can have a broad impact on aggregate supply, mainly through regulations, taxation, and subsidies, which affect production costs and barriers to business operations. By adjusting these policies, governments can directly influence the economic environment and the aggregate supply curve.

A reduction in corporate tax rates is a straightforward way the government can decrease production costs, allowing businesses to reinvest more in production. This leads to an increase in supply, shifting the aggregate supply curve to the right.

• Similarly, building infrastructure or offering tax incentives for research and development can promote growth in supply.

However, increased regulations or higher taxes tend to increase costs, discouraging production. This would result in the aggregate supply curve shifting to the left, indicative of reduced supply. Thus, government decisions play a critical role in shaping the economic landscape and influencing supply levels.

Availability of Inputs

The availability of inputs refers to the ease and abundance with which essential resources such as labor, raw materials, and capital can be accessed for production. Any change in the availability of these inputs affects the ability of businesses to produce goods and services, thus impacting aggregate supply.

When more inputs are available, businesses can produce more goods and services, as there is increased access to the required resources. This results in the aggregate supply curve shifting to the right, reflective of higher production levels.

• For instance, an influx of immigrants increases the labor pool, enabling higher production capacities, and potentially boosting the economy's supply response.

On the other hand, a reduction in the availability of these inputs, such as during a labor strike or a resource shortage, would limit production, causing the aggregate supply curve to shift left. This highlights the importance of input availability in determining the potential output for an economy.