Input Costs

The aggregate supply curve is affected not only by potential output but also by changes in the costs of production. As production costs rise, businesses are willing to supply a given ‘level of output only at how can we the relationship between potential output, costs, and aggregate supply? Figure 31-1 on page 663 illustrates the effect Of changes in potential output and in aggregate supply.The left-hand panel shows that an increase in potential output with no change in production costs would aggregate supply curve outward from AS to AS’.  If production costs were to increase with no change in potential output, !he curve would shift straight up from AS to AS’, as shown in Figure 31-1(b).

The figure shows how the AS curve shifted outward and upward over the period. The outward shift was caused by the increase in potential output that came from growth in the labor force and capital as well as from improvements in technology. The upward shift was caused by increases in the cost of production, as wages, import prices, and other production costs rose. Putting together’ the cost increases and the potential-output growth gives the aggregate supply shift shown in Figure 31-2.