What this lesson teaches
I can explain what shifts aggregate supply.
Syllabus 9570, 3.1.2(c). Aggregate Demand and Aggregate Supply: How Aggregate Supply (AS) is affected by its determinants
Make a guess
Real output rises 4% as idle factories reopen after a recession. Has productive capacity grown?
- Yes, because the factories are producing again.
- Yes. Higher output always means more capacity.
- No. Existing resources are back in use.
Show the answer
No. Existing resources are back in use.
Productive capacity is the most the economy can make with all its resources. Reopening idle factories moves output towards that limit without raising it.
Using idle resources raises output without raising capacity; productive capacity grows only with more or better resources.
Spare capacity means the economy is producing less than it could: workers are unemployed and machines are idle. A rise in AD can bring them back into use.
Productive capacity is the most the economy can produce with all its resources. It is shown by the full-employment level of output, Yf.
Productive capacity grows when the quantity or quality of resources increases: more workers, more capital, better skills or better technology. On the diagram, AS shifts right and Yf rises.
This is long-run economic growth, and it lets output rise without inflation. Singapore's focus on productivity, skills and technology aims to do this.
- Spare capacity
- Idle resources; output can rise without new capacity.
- Productive capacity
- Grows with more or better resources; AS and Yf shift right.
Worked example: The same rise in demand, two economies
Suppose AD rises by the same amount in two economies. Economy A has lots of spare capacity; economy B is near full employment.
- Economy A: output rises a lot and prices rise a little (from index 100 to 120 and 110).
- Economy B: output rises a little and prices rise a lot (100 to 110 and 120).
- Neither change shows that productive capacity grew; both used existing resources.
- To keep growing without inflation, economy B needs more or better resources.
Watch out for this
Any rise in real output shows that productive capacity has grown.
Output can rise because idle resources come back into use. Productive capacity grows only with more or better resources.
Check your understanding
Which of these increases Singapore's productive capacity?
- Unemployed workers find jobs in a recovery.
- Consumers spend more during festive seasons, so firms produce more.
- Firms adopt automation that raises output per worker.
Show the answer
Firms adopt automation that raises output per worker.
Right. Higher productivity shifts AS right and raises Yf.