Shifts in Aggregate Supply and Demand
Learning Objectives
By the end of this section, you will be able to:
- Explain how productivity growth changes the aggregate supply curve
- Explain how changes in input prices change the aggregate supply curve
- Explain how imports influence aggregate demand
- Identify ways in which business confidence and consumer confidence can affect aggregate demand
- Explain how government policy can change aggregate demand
The original equilibrium in the AD/AS diagram will shift to a new equilibrium if the AS or AD curve shifts. When the aggregate supply curve shifts to the right, then at every price level, producers supply a greater quantity of real GDP. When the AS curve shifts to the left, then at every price level, producers supply a lower quantity of real GDP. Likewise, when the aggregate demand curve shifts to the right, then at every price level, consumers demand a greater quantity of real GDP. And when the AD curve shifts to the left, then at every price level, consumers demand a lower quantity of real GDP. This module discusses the most important factors that can lead to shifts in the AS and AD curves.
How Productivity Growth Shifts the AS Curve
In the long run, the most important factor shifting the AS curve, and thereby leading to long run economic growth, is productivity growth. Productivity means how much output can be produced with a given quantity of labor. One measure of this is output per worker or GDP per capita. Over time, productivity grows so that the same quantity of labor can produce more output. Historically, the real growth in GDP per capita in an advanced economy like the United States has averaged about 2% to 3% per year, but productivity growth has been faster during certain extended periods like the 1960s and the late 1990s through the early 2000s, or slower during periods like the 1970s and 2010s. A higher level of productivity shifts the AS curve to the right, because with improved productivity, firms can produce a greater quantity of output at every price level. Figure 1 (a) shows an outward shift in productivity over two time periods. The AS curve shifts out from SRAS0 to SRAS1 to SRAS2, and the equilibrium shifts from E0 to E1 to E2. Note that with increased productivity, workers can produce more GDP. Thus, full employment corresponds to a higher level of potential GDP, which we show as a rightward shift in LRAS from LRAS0 to LRAS1 to LRAS2.
A shift in the SRAS curve to the right will result in a greater real GDP and downward pressure on the price level, if aggregate demand remains unchanged. However, if this shift in SRAS results from gains in productivity growth, which we typically measure in terms of a few percentage points per year, the effect will be relatively small over a few months or even a couple of years. Recall how in Choice in a World of Scarcity, we said that a nation’s production possibilities frontier is fixed in the short run, but shifts out in the long run? This is the