Shifts in Aggregate Supply

Updated Jun 26, 2020

Aggregate Supply (AS) describes the total amount of goods and services sellers are willing to sell within a particular market. According to classical macroeconomic theory, the aggregate supply curve is perfectly vertical in the long run, although it may slope upward in the short term. That means, over the long term, the economy always produces what is called its natural rate of output (i.e., the full potential output). However, there are factors that can change the natural rate of output. In particular, the level of supply depends on labor, capital, natural resources, and technological knowledge. Thus, similar to shifts in aggregate demand, any change in one of those factors can cause shifts in aggregate supply. We will look at each of them in more detail below.

1. Shifts Arising from Labor

Any event that changes the size and utilization of the workforce shifts the aggregate supply curve. That means whenever the workforce grows, or the natural rate of unemployment decreases, the long-run aggregate supply curve shifts to the right and vice versa. The government can influence the availability of labor directly or indirectly through immigration laws or minimum wage requirements.

To illustrate this, assume the government passes a law to restrict immigration. As a result, fewer workers can enter the country, the quantity of goods and services supplied decreases, and AS shifts to the left. By contrast, if the government decides to lower minimum wages, the natural rate of unemployment decreases (i.e., hiring additional workers becomes cheaper), and the long-run aggregate supply curve shifts to the right.

2. Shifts Arising from Capital

Any event that changes the capital stock available within the economy also shifts aggregate supply. That means whenever the economy’s physical or human capital stock increases, productivity rises, the aggregate supply curve shifts to the right, and vice versa. Policymakers can influence the capital stock indirectly through different forms of taxation (e.g., income taxes) or subsidies (e.g., scholarships).

For example, let’s say the government increases the income tax firms have to pay on their profits. This reduces the amount of money the suppliers can reinvest in their business. As a result, the quantity of goods and services supplied decreases, and AS shifts to the left. Meanwhile, if the government decides to provide free university education for everyone, the number of graduates increases, and the economy becomes more productive. As a result, aggregate supply shifts to the right.

3. Shifts Arising from Natural Resources

Any event that changes the availability of natural resources has the power to shift the aggregate supply curve as well. That means if new mineral deposits are discovered, additional land becomes accessible, or weather patterns change in favor of agriculture, aggregate supply shifts to the right, and vice versa. Governments generally cannot influence whether and where natural resources are available. However, if the resources are within their control, policymakers can affect their availability by restricting access to them.

For example, assume the government finds a new oil deposit. This increases the oil supply, which in turn shifts AS to the right. However, if the government restricts access to all oil deposits to protect the environment, firms need to find new energy sources, and AS shifts to the left.

4. Shifts Arising from Technological Knowledge

Finally, any event that changes the technological knowledge within an economy shifts aggregate supply. That means whenever new inventions or innovations are introduced, the aggregate supply curve usually shifts to the right. Unlike the other factors mentioned above, there are virtually no cases of technological improvements that cause AS to shift to the left. After all, firms wouldn’t introduce new technologies that are not beneficial to them. However, the government can pass regulations that prevent firms from using certain technologies, which can still shift aggregate supply to the left.

To illustrate this, let’s assume scientists have developed a new and more efficient process to harness solar energy. This innovation increases productivity and shifts AS to the right. Meanwhile, if the government passes new regulations to prevent firms from utilizing nuclear power because of security concerns, suppliers must yet again find other energy sources and aggregate supply shifts to the left.

Summary

Aggregate Supply (AS) describes the total amount of goods and services sellers are willing to sell within a particular market. In the long run, the aggregate supply curve is perfectly vertical at the natural rate of output. This level of output depends on labor, capital, natural resources, and technological knowledge. Any change in one of those factors can cause shifts in aggregate supply.