How do productivity changes influence AS?

Productivity changes influence Aggregate Supply (AS) by affecting the cost of production and potential output levels.

Productivity, in economic terms, refers to the efficiency with which inputs are converted into outputs. When productivity increases, it means that a given amount of inputs can produce more outputs. This has a direct impact on the Aggregate Supply (AS) curve. AS represents the total quantity of goods and services that firms are willing and able to supply at different price levels.

If productivity improves, firms can produce more goods and services with the same amount of inputs. This reduces the cost of production per unit, allowing firms to supply more at each price level. As a result, the AS curve shifts to the right, indicating an increase in aggregate supply. This is often associated with economic growth, as it allows the economy to produce more without increasing its use of resources.

On the other hand, if productivity decreases, firms need more inputs to produce the same amount of goods and services. This increases the cost of production per unit, reducing the quantity that firms are willing to supply at each price level. Consequently, the AS curve shifts to the left, indicating a decrease in aggregate supply. This can lead to economic contraction, as the economy produces less with the same amount of resources.

Moreover, changes in productivity can also affect the potential output of an economy, which is the maximum amount of goods and services an economy can produce when all resources are fully employed. Higher productivity increases the potential output, shifting the long-run AS curve to the right. Conversely, lower productivity reduces the potential output, shifting the long-run AS curve to the left.

In conclusion, productivity changes play a crucial role in determining the position and shape of the AS curve. They influence the cost of production and the potential output, which in turn affect the quantity of goods and services that firms are willing and able to supply at different price levels. Therefore, understanding the relationship between productivity and AS is key to analysing the dynamics of an economy.