The supply curve shows how much of a good or service sellers are willing to sell at any given price. However, it is not constant over time. Whenever a change in supply occurs, the supply curve shifts left or right (similar to shifts in the demand curve). An increase in supply results in an outward shift of the supply curve (i.e. to the right), whereas a decrease in supply results in an inward shift (i.e. to the left). There are a number of factors that cause a shift in the supply curve: input prices, number of sellers, technology, natural and social factors, as well as expectations. We will look at each of them in more detail below. Show Input pricesFirms use a number of different inputs to produce any kind of good or service (i.e. output). When the prices of those inputs increase, the firms face higher production costs. As a result, producing said good or service becomes less profitable and firms will reduce supply. That is the supply curve shifts to the left (i.e. inward). By contrast, a decrease in input prices reduces production costs and therefore shifts the supply curve to the right (i.e. outward). For example, your favorite restaurant needs several ingredients to make a burger: buns, meat, lettuce, tomatoes, BBQ sauce, and so on. Now, imagine the price of meat increases. That means the restaurant faces higher costs for every burger it produces. If the price of the burger remains the same, this results in a smaller profit for the restaurant. Because of this, the restaurant will produce fewer burgers and focus on other dishes that are more profitable. Therefore the supply of burgers decreases, as the price of meat increases. If the price of meat increases a lot, some restaurants may even decide to shut down and go out of business, because they cannot earn profits anymore. This reduces supply even further. By contrast, if the price of meat decrease, it becomes more attractive to sell burgers, which results in an increase in supply. Hence, supply is negatively correlated to the price of the inputs used in production. Number of SellersThe number of sellers in a market has a significant impact on supply. When more firms enter a market to sell a specific good or service, supply increases. That is the supply curve shifts to the right. Meanwhile, when firms exit the market, supply decreases, i.e. the supply curve shifts to the left. This may seem pretty obvious, but nevertheless, it is an important factor to keep in mind. To give an example, let’s say there is only one burger restaurant in the entire economy. We’ll call it First Burger. Demand for burgers is high, so First Burger already produces as many burgers as possible. In this scenario, the total supply of burgers in the economy is equal to First Burger’s supply. Now a new burger restaurant opens nearby – Second Burger. This results in an increase in the total supply of burgers in the economy, which is now equal to the sum First Burger’s and Second Burger’s individual supply. TechnologyThe use of advanced technology in the production process increases productivity, which makes the production of goods or services more profitable. As a result, the supply curve shifts right, i.e. supply increases. Please note that technology in the context of the production process usually only causes an increase in supply, but not a decrease. The reason for this is simple: new technology is only adopted if it increases productivity. Otherwise, sellers can just stick with the technology they already have, which does not affect productivity (and thus supply). For example, the highly standardized and technologically advanced processes used in many fast-food burger restaurants significantly increased productivity and thereby the supply of burgers all over the world. Of course, the restaurants have no incentive to alter those processes, unless they can be made even more efficient. Natural and Social FactorsThere are always a number of natural and social factors that affect supply. They can either affect how much output sellers can produce or how much they want to produce. Whenever one of those factors causes supply to decrease, the supply curve shifts to the left, whereas an increase in supply results in a shift to the right. As a rule of thumb, natural factors generally affect how much sellers can produce, while social factors have a greater effect on how much they want to produce. Examples of natural factors that affect supply include natural disasters, pestilence, diseases, or extreme weather conditions. Basically, anything that can have an effect on inputs or facilities that are required in the production process. Meanwhile, examples of social factors include increased demand for organic products, waste disposal requirements, minimum wage laws, or government taxes. Note that not all of those factors necessarily have an impact on the cost of production, but all of them affect production decisions. ExpectationsLast but not least, the seller’s expectations of the future have a significant impact on supply. Or more specifically, their expectations of future prices and/or other factors that affect supply. If they expect prices to increase in the near future, they will hold some of their output back (i.e. reduce current supply) in order to increase supply in the future, when it becomes more profitable. For example, let’s say there’s going to be a huge annual country festival in town next week. During the festival, demand for burgers spikes significantly every year, which usually increases prices by a few dollars. Therefore, First Burger restaurant decides to keep some of this weeks ingredients in the storeroom and use them to make some additional burgers during the festival. In a NutshellSupply is not constant over time. It constantly increases or decreases. Whenever a change in supply occurs, the supply curve shifts left or right. There are a number of factors that cause a shift in the supply curve: input prices, number of sellers, technology, natural and social factors, and expectations.
Learning Objectives
In this section we introduce supply shocks. Supply shocks are events that shift the aggregate supply curve. We defined the AS curve as showing the quantity of real GDP producers will supply at any aggregate price level. When the aggregate supply curve shifts to the right, then at every price level, a greater quantity of real GDP is produced. This is called a positive supply shock. When the AS curve shifts to the left, then at every price level, a lower quantity of real GDP is produced. This is a negative supply shock. This module discusses two of the most important supply shocks: productivity growth and changes in input prices.
How Productivity Growth Shifts the AS CurveIn the long run, the most important factor shifting the AS curve is productivity growth. Productivity means how much output can be produced with a given quantity of inputs. One measure of this is output per worker or GDP per capita. Over time, productivity grows so that the same quantity of labor can produce more output. Historically, the real growth in GDP per capita in an advanced economy like the United States has averaged about 2% to 3% per year, but productivity growth has been faster during certain extended periods like the 1960s and the late 1990s through the early 2000s, or slower during periods like the 1970s. A higher level of productivity shifts the AS curve to the right, because with improved productivity, firms can produce a greater quantity of output at every price level. The interactive graph below (Figure 1) shows an outward shift in productivity over two time periods. The AS curve shifts out from SRAS0 to SRAS1 and LRAS0 to LRAS1, reflecting the rise in potential GDP in this economy, and the equilibrium shifts from E0 to E1.
A shift in the SRAS curve to the right will result in a greater real GDP and downward pressure on the price level, if aggregate demand remains unchanged. However, productivity grows slowly, at best only a few percentage points per year. As a consequence, the resulting shift in SRAS, increase in Q and decrease in P will be relatively small over a few months or even a couple of years.
How Changes in Input Prices Shift the AS CurveHigher prices for inputs that are widely used across the entire economy, such as labor or energy, can have a macroeconomic impact on aggregate supply. Increases in the price of such inputs represent a negative supply shock, shifting the SRAS curve to shift to the left. This means that at each given price level for outputs, a higher price for inputs will discourage production because it will reduce the possibilities for earning profits. The interactive graph below (Figure 2) shows the aggregate supply curve shifting to the left, from SRAS0 to SRAS1, causing the equilibrium to move from E0 to E1. The movement from the original equilibrium of E0 to the new equilibrium of E1 will bring a nasty set of effects: reduced GDP or recession, higher unemployment because the economy is now further away from potential GDP, and an inflationary higher price level as well. For example, the U.S. economy experienced recessions in 1974–1975, and 1980–1981 that were each preceded or accompanied by a rise in oil prices. In the 1970s, this pattern of a shift to the left in AS leading to a stagnant economy with high unemployment and inflation was nicknamed stagflation.
Conversely, a decline in the price of a key input like oil, represents a positive supply shock shifting the SRAS curve to the right, providing an incentive for more to be produced at every given price level for outputs. From 1985 to 1986, for example, the average price of crude oil fell by almost half, from $24 a barrel to $12 a barrel. Similarly, from 1997 to 1998, the price of a barrel of crude oil dropped from $17 per barrel to $11 per barrel. In both cases, the plummeting price of oil led to a situation like that presented earlier in Figure 1, where the outward shift of SRAS to the right allowed the economy to expand, unemployment to fall, and inflation to decline.
Along with wages and energy prices, another source of supply shocks is the cost of imported goods that are used as inputs for domestically-produced products. In these cases as well, the lesson is that lower prices for inputs cause SRAS to shift to the right, while higher prices cause it to shift back to the left. Similarly, an unexpected early freeze could destroy a large number of agricultural crops, a shock that would shift the AS curve to the left since there would be fewer agricultural products available at any given price. When Does A Supply Shock Shift Potential GDP?This important question really answers itself. Suppose there is a decrease in aggregate demand, which is shown by a leftward shift in AD, as shown in Figure 2. In the short term, wages are sticky and output decreases along the SRAS, as we move from E1 to E2. Over time, wages decrease and as they do, the SRAS shifts to the right due to the decrease in firms’ cost of production. The SRAS continues to shift until GDP has returned to potential. Graphically, we move from E2 to E3. Because this event was caused by a demand shock (i.e. a shift in AD), it had no effect on potential GDP. The supply of labor didn’t change, nor did labor productivity so LRAS stays constant, though SRAS shifted. LRAS shifts only when the potential GDP increases or decreases.  Figure 3. A Demand Shock. When AS shifts in response to a shift in AD, potential GDP (and LRAS) is unchanged. Rather, the model adjusts back to the original potential GDP, moving from E1 to E3.
Review things that shift aggregate supply in the following video. You can view the transcript for “Short-Run Aggregate Supply- Macro Topic 3.3” here (opens in new window). The video went over the following scenarios. Take a second look and quiz yourself on what will happen to aggregate supply in each situation.
These questions allow you to get as much practice as you need, as you can click the link at the top of the first question (“Try another version of these questions”) to get a new set of questions. Practice until you feel comfortable doing the questions.
negative supply shock: a leftward shift in the SRAS and LRAS curves positive supply shock: a rightward shift in the SRAS and LRAS curves stagflation: an economy experiences stagnant growth and high inflation at the same time supply shock: an event that shifts both short run and long run aggregate supply curves Contribute!Did you have an idea for improving this content? We’d love your input. Improve this pageLearn More |
What causes the market supply curve to shift rightward?
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