What this lesson teaches
I can explain what shifts aggregate supply.
Syllabus 8843, 3.1.1(c). Aggregate Demand and Aggregate Supply: How Aggregate Supply (AS) is affected by its determinants
Make a guess
The economy is already at full employment, and spending rises sharply. What happens?
- Prices rise; real output barely changes.
- Output rises a lot, because firms want to sell more.
- Nothing, because AS cannot change.
Show the answer
Prices rise; real output barely changes.
At full employment there are no spare workers or machines. AS is close to vertical, so extra spending mostly pushes up the price level.
AS is flat when there is lots of spare capacity, then gets steeper, and is vertical at full employment.
Aggregate supply is the total real output firms are willing and able to produce at each general price level.
When there is a lot of spare capacity, as in a recession, firms can raise output without raising costs, so AS is almost flat.
As the economy nears full capacity, bottlenecks appear: skilled workers and machines become scarce, so costs and prices rise faster. AS gets steeper.
At full employment (Yf), the economy cannot produce more with its current resources, so AS is vertical. AS shifts up if costs rise, and shifts right if productive capacity grows.
- Flat
- Lots of spare capacity.
- Rising
- Bottlenecks.
- Vertical
- Full employment, Yf.
Worked example: Imported fuel becomes more expensive
Fuel is used in almost every industry, and Singapore imports all of it. The price of fuel rises. Later, firms install equipment that uses less energy.
- Higher fuel costs raise the cost of producing every level of output, so AS shifts up.
- At the same AD, the price level rises and real output falls: cost-push inflation.
- Energy-saving equipment later lowers costs, shifting AS back down, and may also raise productive capacity.
Watch out for this
AS shows how much firms want to produce, so it can always rise if demand rises.
At full employment, the economy has no spare resources. AS is vertical there, so higher demand only raises prices.
Check your understanding
Which change shifts the AS curve to the right?
- A rise in productive capacity, such as a better-trained workforce.
- A rise in consumer spending as households grow more confident about jobs.
- A rise in wages across the economy without more output per worker.
Show the answer
A rise in productive capacity, such as a better-trained workforce.
Right. More capacity lets firms produce more at each price level, so AS shifts right.