How Productivity Growth Shifts the AS Curve

The original equilibrium in the AD/AS diagram will shift to a new equilibrium if the AS or AD curve shifts. When the aggregate supply curve shifts to the right, then at every price level, a greater quantity of real GDP is produced. When the SRAS curve shifts to the left, then at every price level, a lower quantity of real GDP is produced. This module discusses two of the most important factors that can lead to shifts in the AS curve: productivity growth and input prices.

How Productivity Growth Shifts the AS Curve

In the long run, the most important factor shifting the AS curve is productivity growth. Productivity means how much output can be produced with a given quantity of labor. One measure of this is output per worker or GDP per capita. Over time, productivity grows so that the same quantity of labor can produce more output. Historically, the real growth in GDP per capita in an advanced economy like the United States has averaged about 2% to 3% per year, but productivity growth has been faster during certain extended periods like the 1960s and the late 1990s through the early 2000s, or slower during periods like the 1970s. A higher level of productivity shifts the AS curve to the right, because with improved productivity, firms can produce a greater quantity of output at every price level. Figure (a) shows an outward shift in productivity over two time periods. The AS curve shifts out from SRAS₀ to SRAS₁ to SRAS₂, reflecting the rise in potential GDP in this economy, and the equilibrium shifts from E₀ to E₁ to E₂.

Shifts in Aggregate Supply

(a) The rise in productivity causes the SRAS curve to shift to the right. The original equilibrium E₀ is at the intersection of AD and SRAS₀. When SRAS shifts right, then the new equilibrium E₁ is at the intersection of AD and SRAS₁, and then yet another equilibrium, E₂, is at the intersection of AD and SRAS₂. Shifts in SRAS to the right, lead to a greater level of output and to downward pressure on the price level. (b) A higher price for inputs means that at any given price level for outputs, a lower quantity will be produced so aggregate supply will shift to the left from SRAS₀ to AS₁. The new equilibrium, E₁, has a reduced quantity of output and a higher price level than the original equilibrium (E₀).

A shift in the SRAS curve to the right will result in a greater real GDP and downward pressure on the price level, if aggregate demand remains unchanged. However, if this shift in SRAS results from gains in productivity growth, which are typically measured in terms of a few percentage points per year, the effect will be relatively small over a few months or even a couple of years.