Consumer Spending Habits: Changes in Aggregate Supply

Changes in Aggregate Supply The amount the sellers will produce does not depend on the price level alone. Changes in wages and other input prices, changes in the quality and quantity of resources available, as well as advances in technology will change the aggregate quantity supplied at each possible price level. A change in aggregate supply is a change in the amount of national production resulting from something other than a change in the price level. A change in aggregate supply implies a shift of the economy's aggregate supply curve. Remember that the aggregate supply curve is drawn under the assumption that the level of all input prices, including the price of labor (nominal wages), the availability and quality of inputs, and technology are fixed. A decrease in aggregate supply is represented by an inward shift of the aggregate supply curve. Similarly, an increase in aggregate supply is represented by an outward shift of the aggregate supply curve. How Changes in Input Prices Affect Aggregate Supply Some changes in the economy that change aggregate supply, however, have little impact on the levels of real GNP that correspond to potential real GNP and the nation's physical limit to output for the year. Consider the impact of a change in nominal wages on aggregate supply. As nominal wages go up, the unit and marginal costs of production also increase decreasing the profitability of selling output at any given price level. Because firms now require higher prices to make any given level of output available, the aggregate supply curve shifts inward just like a market supply curve shifts inward in response to an increase in wages. However, the wage increase itself affects neither the economy's potential real GNP nor the level of output corresponding to the economy's physical limit to production. The graph in Box 7 illustrates a decrease in aggregate supply that results from an increase in nominal wages or an increase in other input prices (such as fuel prices). Notice that the curve shifts inward, but the level of output for which the curve becomes vertical does not change. The level of output corresponding to potential real GNP and the economy's physical limit to output does not change. A decrease in nominal wages or a decrease in fuel prices would increase aggregate supply without affecting potential real GNP or the level of real GNP corresponding to the economy's capacity output. Lower input prices increase profit opportunities and induce businesses to increase the aggregate quantity supplied at each possible price level. The graph in Box 8 shows how a decrease in input prices affects the aggregate supply curve. For example, suppose the price of oil, a key input used in production, falls by 20 percent during the year. This means the unit and marginal costs of production will also fall. This induces businesses to increase the aggregate quantity supplied at any given price level. The decrease in oil prices itself, however, does not change the level of real GNP corresponding to potential real GNP or to the physical limit to output during the year. How Changes in the Quantity or Productivity of Inputs Affect Aggregate Supply Changes in the availability or productivity of resources and advances in technology increase or decrease aggregate supply and also change the levels of output corresponding to potential real GNP and the nation's capacity output. The graph in Box 9 shows an increase in aggregate supply that results when changes in the economy affect the nation's potential real GNP and the level of real GNP corresponding to capacity output. For example, an increase in the size of the labor force means that more labor hours are available for production. Because of the increased labor, potential real GNP is greater and so is the actual capacity of the economy to produce goods and services. Similarly, an increase in the nation's capital stock will increase aggregate supply because more capital means that a given labor force has more tools with which to work. Naturally with more tools, labor will be more productive and will be able to produce more. The graph in Box 9 shows that, as a result of the increase in availability of inputs, both potential real GNP and the level of real GNP corresponding to the physical limit to product (for which the aggregate supply curve becomes vertical increase as aggregate supply increases. An increase in the availability of raw materials could also increase aggregate supply as illustrated in Box 9. Improvements in the quality of inputs is another important cause of increases in aggregate supply that also increase potential real GNP. For example, improvement of the educational level of the labor force is a major factor resulting in such increases in aggregate supply. Advances in technology, such as new and faster computers, and automated production techniques also contribute to such outward shifts in aggregate supply. Although it is normal for aggregate supply to increase over time as the availability and productivity of resources increase, there are occasionally some unfortunate setbacks as a result of natural or social catastrophes that can result in decreases in aggregate supply. For example, there was a severe drought in the United States in 1988 that resulted in a decrease in aggregate supply that year. Wars and natural disasters, such as earthquakes and hurricanes, can destroy productive resources and result in decreases in aggregate supply. A sharp cutoff in imported supplies of oil, as occurred in the 1970s in the United States as a result of the OPEC oil embargo, can also cause a decrease in aggregate supply. Box 10 shows a decrease in aggregate supply resulting from a decrease in resource availability; it also shows how both potential real GNP and the nation's capacity output decline as a consequence.