Check Your Understanding

1. Question

   Determine the effect on short-run aggregate supply of each of the following events. Explain whether it represents a movement along the SRAS curve or a shift of the SRAS curve.

   1. A rise in the consumer price index (CPI) leads producers to increase output.

      This represents a movement along the SRAS curve because the CPI—like the GDP deflator—is a measure of the aggregate price level, the overall price level of final goods and services in the economy.

   2. A fall in the price of oil leads producers to increase output.

      This represents a shift of the SRAS curve because oil is a commodity. The SRAS curve will shift to the right because production costs are now lower, leading to a higher quantity of aggregate output supplied at any given aggregate price level.

   3. A rise in legally mandated retirement benefits paid to workers leads producers to reduce output.

      This represents a shift of the SRAS curve because it involves a change in nominal wages. An increase in legally mandated benefits to workers is equivalent to an increase in nominal wages. As a result, the SRAS curve will shift leftward because production costs are now higher, leading to a lower quantity of aggregate output supplied at any given aggregate price level.

2. Question

   Suppose the economy is initially at potential output and the quantity of aggregate output supplied increases. What information would you need to determine whether this was due to a movement along the SRAS curve or a shift of the LRAS curve?

   You would need to know what happened to the aggregate price level. If the increase in the quantity of aggregate output supplied was due to a movement along the SRAS curve, the aggregate price level would have increased at the same time as the quantity of aggregate output supplied increased. If the increase in the quantity of aggregate output supplied was due to a rightward shift of the LRAS curve, the aggregate price level might not rise. Alternatively, you could make the determination by observing what happened to aggregate output in the long run. If it fell back to its initial level in the long run, then the temporary increase in aggregate output was due to a movement along the SRAS curve. If it stayed at the higher level in the long run, the increase in aggregate output was due to a rightward shift of the LRAS curve.