Shifts in Aggregate Supply

The Aggregate Supply curve shifts when tech­nology changes or when resource availability or costs change. Technological advances boost Aggregate Supply, while disruptions in resource markets, higher tax rates, or inefficient new gov­ernment regulations are among negative shocks to Aggregate Supply.

• Shocks Operating Through the Labor Market The notion that enhanced incentives to supply resources would boost Aggregate Supply was at the heart of the 25% cut in tax rates during 1981 to 1983 and was also partially responsible for attempts to cut growth in gov­ernment transfer payments. The Reagan ad­ministration felt that this strategy would boost Aggregate Supply more than these tax cuts in­creased Aggregate Demand, so that substantial growth would more than offset any emerging inflationary pressure. Naturally, higher mar­ginal tax rates would reduce the effective sup­ply of labor and, consequently, Aggregate Supply.

A second type of labor market disturbance would occur if the power of unions grew and they commanded higher wages. Wage hikes raise production costs and push up prices, shrinking Aggregate Supply. This potential problem has diminished in importance over the last two decades as union membership as a per­cent of the workforce has declined not only in the United States but worldwide.

More recently, the restructuring of American industry has led to serious changes in most labor markets. Global competition, rapidly changing technology, expanded labor legisla­tion, and a broader legal liability of firms for var­ious labor issues have resulted in corporate downsizing and more intensive use of a contin­gency labor force. The wholesale trimming of employees in many companies has led some to argue that many corporate employees who man­aged to keep their jobs are now overworked.

Another problem area would be any rise in the inflation rate workers expect. Inflationary expectations continuously shift labor supply curves leftward as workers try to protect the pur­chasing power of their earnings. Naturally, de­creases in inflationary expectations or in union power will shift the labor supply and Aggregate Supply curves toward the right. Finally, people's preferences between work and leisure obviously affect Aggregate Supply.

• Incomes Policies Some analysts think that incomes policies may moderate inflationary ex­pectations. The term "incomes policy" refers to measures intended to curb inflation without al­tering monetary or fiscal policies. These meth­ods include moral suasion, wage-and-price guidelines or controls, and wage-price freezes of the type imposed in 1971. President Nixon hoped the freeze would reduce expected infla­tion and halt continuous shrinkage of Aggregate Supply. Ideally, it might have increased the sup­plies of labor and output.

Unfortunately, incomes policies may per­versely affect inflationary expectations and Aggregate Supply. If workers and firms share a belief that prices will soar soon after controls are lifted, they may withhold production from the market now in hopes of realizing higher wages or prices later. For example, suppose you face the following choice: you can (a) work during a period when wages are frozen and save money to cover your college expenses or (b) borrow to go to college during a freeze and then repay the loanfrom funds you earn after the lid is removed from wage hikes. You (and many other people) might delay working until after the freeze. Incomes policies also hinder necessary relative price adjustments; the resulting distortions in economic behavior retard Aggregate Supply.

• Other Shocks Affecting Productive Capacity New regulations that hamper pro­duction shift the Aggregate Supply curve to the left, but elimination of inefficient regula­tion shifts the curve rightward. From the mid-1970s onward, deregulation and privatization of parts of our economy have been aimed at re­moving inefficiency and boosting Aggregate Supply.

Technological advances expand Aggregate Supply, while external shocks that raise costs for imports or resources willshrink Aggregate Supply. Shocks to the U.S. economy occurred when OPEC coalesced in 1973 and world oil prices quadrupled shortly thereafter. Most in­dustrialized countries endured painful leftward shifts in their Aggregate Supply curves. Rightward shifts occur when new resources are found. For example, Great Britain discovered oil in the North Sea, and exploitation of huge pools of Mexican oil during the late 1970s helped Mexico. Gluts of oil on world markets and the relative instability of OPEC drove prices down; energy costs fell from the mid-1980s onward, boosting our Aggregate Supply to the right.

Influences that shift Aggregate Supply are listed in Figure 5. Understanding macroeconomic movements requires a good grasp of these con­cepts. We will now survey some recent theories developed by new Keynesian economists to ex­plain why wages are sticky, causing involuntary unemployment to persist during some periods. (14827 digits)

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