BAB 1.8 AGGREGATE SUPPLY AND DEMAND IV : SHIFTS IN AGGREGATE SUPPLY [MUSIC]So we've seen what causes aggregate demand to move. And this is often what drives the economy. Aggregate demand seems to move more than aggregate supply. But we've also commented on the fact that when aggregate supply moves, we see really dramatic things happening in the economy, sometimes very pleasant or very unpleasant. So it's important to see what can move aggregate supply as well. So if you go back to this picture you're drawing and just kind of copy these movements as I talk about them. What is it that could cause the aggregate supply curve for the whole economy to move? Well, this is pretty simple basically anything that changes the cost of production in a substantial way is going to move that aggregate supply curve. Now, we have to think about the fact that aggregate supply is all producers in the whole economy. Okay? So it can't be just some small thing that affects costs in one industry. These are usually very big events. We call them, often, supply shocks. There can be positive supply shocks. There can be negative supply socks, shocks. But they're big events that tend to affect most producers in the economy. So, for example, I've mentioned here labor costs or worker benefits. Imagine that we pass a new law, and maybe some people are thinking of Obamacare in this way, right, although I have not analyzed its effect on labor costs in the U.S. economy. Imagine we pass some new law that requires everyone to spend extra on their workers. An example that comes to my mind is in France in the year 2000 they passed the 35 hour work week. Now the 35 hour work week sounds good, you can work 35 hours instead of 40, except that companies were required to pay the same amount of money for 35 hours as they had for 40. What happened? Well their labor costs per unit of output, assuming their workers produce less in 35 hours then they do in 40, went up. All right? And so the average supply curve would shift inward to the left because the costs of production are higher. Other things I've mentioned here, taxes. A new tax that is imposed on businesses, that makes it more expensive for them to produce. Maybe we decide to tax their emissions, which would be a good thing from the environmental perspective. It would however, definitely raise their production cost unless they find a way to produce more cleanly. Aggregate supply would shift to the left. Raw material prices, this is the most common cause of shifts in aggregate supply; at least the one we hear the most about. Imagine petroleum prices goes up, as they did abruptly in the 70s, the end of the 70s as it did just before this financial crisis. If these prices go up, almost every company and producing unit across the economy finds itself with higher energy costs. And so the aggregate supply curve will shift to the left because it costs us more to produce the same amount that we did before. I also include here regulations and government policy because they can have an effect. There are regulations that are important, that are necessary, that are positive for the economy. But they can also have a cost for businesses. That doesn't mean we shouldn't pass those regulations, because probably we're pursuing some other objective. But we should never ignore the fact that if they have an impact, a large enough impact, impact on business cost, aggregate supply will shift inward to the left. Now if you're drawing this, you know what happens when aggregate supply shifts inward to the left. We find ourselves with lower GDP, lower unemployment, and a higher inflation. So, it's a worst of all possible worlds. It's stagflation. This is why we're so concerned about these negative supply shocks. The good news, though, is that sometimes the aggregate supply curve moves in the opposite direction. So imagine, I don't know, beginning of the 80s petroleum prices collapse globally. The aggregate supply curve shifts outward to the right. All right, and we find ourselves with less inflation, and less unemployment while we grow. Wonderful, best of all possible words. Maybe a deregulation effort. Again, we need to be careful about just deregulation for deregulation's sake. Because there's good and there's bad regulation, all right? A lot of things do need to be regulated. But, you know, there are a lot of countries that have excessive bureaucratic rules that disrupt the normal functioning of business. If they were to remove some of those rules; aggregate supply could shift outward to the right. We have an example recently in Spain, of a deregulation which was the liberalization of the labor market; where it became easier to fire people. This of course, caused a lot of people to lose their jobs. At the same time it shifted the aggregate supply curve out to the right. So it should leave us, and it is in fact leaving us, with lower inflation and eventually more growth and lower unemployment. So all of these factors can move aggregate supply. Now there are a few more but they're related to costs. And I want you to remember that mainly what moves the aggregate supply curve is changes in costs. Moves to the right when costs go down, moves to the left when costs go up. Technological change can shift aggregate supply, mainly because it affects costs. Imagine the invention of the, of personal computing, the moment when a secretary could have a laptop on her desk, and her boss could too. I mean, think about how much costs could be reduced eventually by these more efficient production methods or just administrative procedures by using computers. So that would cause aggregate supply to shift out to the right. The big inventions of economic history: electricity, the railroad, the steam engine, all of these things, the internet, caused shifts outward in aggregate supply. And related to this are changes in other factors of production. So if there's been a lot of investment in the economy, there's going to be more to produce with. Aggregate supply will shift right. If investment's going down because investors don't believe in the future, our machines are breaking down, our factories need repair, aggregate supply will shift inward to the left. Migration, this is something that we often fail to consider. Imagine that we are allowing immigration into our country. This will raise the quantity of our labor force and the effect will be to move aggregate supply outward to the right, reduce production cost and actually cause us to have more GDP, less unemployment, and less inflation at the same time. If our labor force changes, so we're aging and people are moving out of the workforce, the workforce is shrinking, aggregate supply would move left. Okay? And then it just in general, rising productivity will move aggregate supply to the right. Declining productivity, which is something we don't normally want to have, will move aggregate supply inward to the left. So if we put all these forces together, and if you sit down and look at these last two slides and think about different things that could change in the economy, if you even, tomorrow, pick up a newspaper and look for news on different countries that reflects some of these changes, you can get a pretty good idea with the simple supply and demand diagram that we've been drawing. You can get a pretty good idea of where that economy is going in the future in terms of growth, and, as a result, what will happen to its inflation and to its unemployment rates.[MUSIC] [BLANK_AUDIO]