Movements along and shifts in aggregate supply

Overview

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What you need to know

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Questions from this subtopic

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1. 1

   What causes a movement along an aggregate supply curve, and what causes the curve to shift?

   Model answer

   A movement along the curve is caused only by a change in the general price level, which alters the profitability of production while costs are unchanged and so changes the quantity of output supplied. A shift is caused by a change in the conditions of supply: input costs, taxes on production, subsidies, productivity, or the quantity and quality of the factors of production. A shift changes the output supplied at every price level, not just at one.

2. 2

   Explain the difference between a rise in the general price level and a rise in aggregate supply.

   Model answer

   A rise in the general price level causes an upward movement along an unchanged short-run aggregate supply curve, increasing the quantity of real output supplied because margins have widened. A rise in aggregate supply is a rightward shift of the whole curve, meaning more output is supplied at every price level, and it is caused by lower costs or greater capacity. The first is a response to prices; the second is a change in the underlying conditions of production.

3. 3

   A rise in aggregate demand raises the price level and firms increase output. Is this a shift of aggregate supply or a movement along it?

   Model answer

   It is a movement along the short-run aggregate supply curve. Nothing about firms' costs or capacity has changed; they are simply responding to a higher price for their output while input prices remain fixed. On a diagram with the general price level on the vertical axis and real national output on the horizontal axis, the aggregate demand curve has shifted right and the equilibrium has moved up along the unchanged aggregate supply curve to a higher price level and higher real output.

4. 4

   A national minimum wage increase raises firms' labour costs. Describe what happens on an aggregate supply diagram.

   Model answer

   Costs at every level of output rise, so this is a shift, not a movement. With the general price level on the vertical axis and real national output on the horizontal axis, the short-run aggregate supply curve shifts upwards and to the left, from SRAS1 to SRAS2. With aggregate demand unchanged, the new equilibrium has a higher general price level and lower real national output. Long-run aggregate supply is unaffected unless the higher wage changes the incentive to work or to invest in labour-saving equipment.

5. 5

   Why is it an error to draw a shift in aggregate supply to represent firms producing more when demand rises?

   Model answer

   The extra production is exactly what the upward slope of the short-run aggregate supply curve already describes, so drawing a shift as well counts the same response twice and produces a nonsensical result, typically showing output rising with no change in the price level. A shift must be reserved for a change in the conditions of supply. Firms responding to a better price along an unchanged cost structure are moving along the curve.

6. 6

   Explain what is being held constant when a single short-run aggregate supply curve is drawn.

   Model answer

   The curve holds constant the money prices of all inputs, including wage rates, raw material and energy prices and imported input costs; the state of technology and productivity; the rates of indirect tax and subsidy affecting production; and the quantity and quality of the factors of production available. Only the general price level varies along the curve. Any change in the items held constant requires the curve to be redrawn in a new position.

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