In this lesson, let's turn now to
the upward sloping aggregate supply curve in our aggregate supply–aggregate demand model.
This curve shows that the level of real GDP or
domestic output that will be produced at each price level,
again holding other things constant.
And as I have noted, the aggregate supply curve slopes
upward simply because higher price levels create
an incentive for businesses to produce and sell
additional output while lower price levels reduce output.
And, like the aggregate demand curve,
the aggregate supply curve can shift in or
the aggregate supply curve can shift out depending on various factors.
Now, before we go over the various factors that may
shift the aggregate supply curve inward or outward,
I want to point out one key difference between a shift in
the aggregate demand curve versus a shift in the aggregate supply curve.
Let me illustrate this key difference with this figure.
In the left-hand graph,
I have illustrated an outward shift in
the aggregate demand curve while in the right-hand graph,
I've illustrated an outward shift in the aggregate supply curve,
and you can see that in both cases,
real GDP has increased by exactly the same amount,
Q star minus Q,
indicating more economic growth.
Now, here's another at least slightly tricky question for you.
If you were the benevolent dictator of the economy represented in these two figures,
which scenario would you prefer as a way of seeing the real GDP rise in your country?
Please think carefully about this for
a minute and then jot down your answer before moving on.
Okay. Which scenario would you prefer to
increase real GDP growth by an equivalent amount?
An outward shift of the aggregate demand curve
or an outward shift of the aggregate supply curve?
Well, looking at the figure,
you would clearly prefer the shift in aggregate supply.
This is because you not only get more growth,
you also get a lower inflation rate as the price level falls from P to P star,
and both of these factors are very bullish for your country.
In contrast with an aggregate demand shift,
you do indeed get more growth but you also get more inflation as the price level rises,
which is a problem that you as a dictator will likely have to deal with.
In fact, this single observation about the superiority of
aggregate supply shifts when it comes to stimulating growth while reducing inflation,
captures the essence of a third school of economics we have yet to mention,
that of supply side economics.
We'll talk more about supply side economics in a future lesson but for now,
let's quickly run through the various factors that may lead to supply
side shifts as represented in this figure.
Here, we see three broad categories of shift factors.
The first category is that of the prices of
so-called factor inputs into the production process like land,
labor, capital and energy.
The second category of shift factors includes
elements of the business-government environment such as legal,
regulatory and tax policies.
And the third category captures the state of
a nation's technology and related rates of innovation and productivity.
So, take a minute now to study this figure before we move on to some examples.
Remember, as you study this figure,
that these shift factors are the other things we are holding
constant when we draw the aggregate supply curve.
So, as you study this figure,
try to imagine how each factor might affect the aggregate supply curve.
