Page 224 - Economics

CONFIRMING PAGES

CHAPTER 10
195
Aggregate Demand and Aggregate Supply
of imported resources increases U.S. aggregate supply, and
while an increase in their price reduces U.S. aggregate total input cost
supply. Per-unit production cost _____________

Exchange-rate fluctuations are one factor that may total output
alter the price of imported resources. Suppose that the $2 5
______
$1

dollar appreciates, enabling U.S. firms to obtain more 10
foreign currency with each dollar. This means that Note that we obtain the total input cost by multiplying the
domestic producers face a lower dollar price of imported unit input cost by the number of inputs used.
resources. U.S. firms will respond by increasing their Now suppose productivity increases so
imports of foreign resources, thereby lowering their that real output doubles to 20 units, while
per-unit production costs at each level of output. Falling the price and quantity of the input remain
per-unit production costs will shift the U.S. aggregate constant at $2 and 5 units. Using the above
supply curve to the right. equations, we see that productivity rises
A depreciation of the dollar will have the opposite set from 2 to 4 and that the per-unit production
of effects. W 10.1 cost of the output falls from $1 to $.50. The
Productivity doubled productivity has reduced the per-
Market Power A change in the degree of market and costs unit production cost by half.
power—the ability to set prices above competitive By reducing the per-unit production cost, an increase
levels—held by sellers of major inputs also can affect in productivity shifts the aggregate supply curve to the
input prices and aggregate supply. An example is the fluc- right. The main source of productivity advance is im-
tuating market power held by the Organization of Petro- proved production technology, often embodied within
leum Exporting Countries (OPEC) over the past several new plant and equipment that replaces old plant and
decades. The 10-fold increase in the price of oil that equipment. Other sources of productivity increases are a
OPEC achieved during the 1970s drove up per-unit pro- better-educated and -trained workforce, improved forms
duction costs and jolted the U.S. aggregate supply curve of business enterprises, and the reallocation of labor re-
leftward. Then a steep reduction in OPEC’s market sources from lower- to higher-productivity uses.
power during the mid-1980s resulted in a sharp decline Much rarer, decreases in productivity increase per-unit
in oil prices and a rightward shift of the U.S. aggregate production costs and therefore reduce aggregate supply
supply curve. In 1999 OPEC temporarily reasserted its (shift the curve to the left).
market power, raising oil prices and therefore per-unit
production costs for some U.S. producers (for example,
airlines and truckers). Legal-Institutional Environment
Changes in the legal-institutional setting in which busi-
Productivity nesses operate are the final determinant of aggregate sup-
The second major determinant of aggregate supply is ply. Such changes may alter the per-unit costs of output
productivity , which is a measure of the relationship between and, if so, shift the aggregate supply curve. Two changes of
a nation’s level of real output and the amount of resources this type are (1) changes in taxes and subsidies and (2)
used to produce that output. Productivity is a measure of changes in the extent of regulation.
average real output, or of real output per unit of input:
total output Business Taxes and Subsidies Higher business
Productivity ___________
total inputs taxes, such as sales, excise, and payroll taxes, increase per-
unit costs and reduce short-run aggregate supply in much
An increase in productivity enables the economy to obtain
more real output from its limited resources. It does this by the same way as a wage increase does. An increase in such
reducing the per-unit cost of output (per-unit production taxes paid by businesses will increase per-unit production
cost). Suppose, for example, that real output is 10 units, costs and shift aggregate supply to the left.
that 5 units of input are needed to produce that quantity, Similarly, a business subsidy—a payment or tax break
and that the price of each input unit is $2. Then by government to producers—lowers production costs
and increases short-run aggregate supply. For example,
total output 10 the Federal government subsidizes firms that blend etha-
2
Productivity ___________ ___
total inputs 5 nol (derived from corn) with gasoline to increase the U.S.

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