Tuesday, 21 April 2009

Discuss how an increase in aggregate supply may affect output and inflation



Aggregate supply is the total amount that producers in an economy are willing and able to supply at a given price level in a given time period.
Increase in aggregate supply can meant by the supply curve shift to the right, there is the diagram shows at the above


From this diagram that we know AS shifts outwards and a new macroeconomic equilibrium be established. The price level has fallen and real national output has increase from Y1 to Y2.because the cause of increase AS may be increase the capacity, so the unemployment will be decrease as well. Therefore, the productivity get better, it makes the output increase. But also it is depends on the capacity I think, because if the capacity is small,and you increase in the AS, a limited capacity can not produce more, so increase AS will increase the cost, for example , you need pay variable cost . Also depends on the elasticity of supply, if the AS becomes perfectly inelastic, at full capacity it is not possible to produce and more, irrespective of how high the price level rise.
when we face to inflation , the AS1 curve is on the left to the AS curve, so increase in the AS, can reduce the cost push inflation , because the price level decrease, the cost of production goes down, the factories can produce more to satisfy consumers. But if is the demand pull inflation, the increase AS may push the inflation, which means the inflation will be increase.

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