The Supply Sector and Supply Disturbances

To analyze aggregate supply disturbances, it is useful to utilize an aggregate output market which plots quantities of aggregate output demanded and supplied against price level. The demand curve is constructed from IS and LM curves, while the supply curve is built from the labor market and the aggregate production function for output.

The aggregate supply disturbances which have attracted the most attention in the United States during the past several decades are wage-push inflation, the cost-push inflation involved in the sharp increases in prices of imported oil posted during 1973 and 1974 by the newly effective cartel of international oil producers, technological advance, and labor supply effects of expansions in income-maintenance programs and shifts in labor force composition.

Wage-push inflation occurs when unions apply monopoly power over the supply of labor to obtain money-wage gains in excess of productivity increases and producers recover their increased costs by passing on the increases as higher prices. Prices and money wages are pushed up by the exercise of monopoly power rather than being bid up by excess demand. Shortfall unemployment appears if the aggregate demand for output curve is unchanged, since the higher prices reduce the real money supply and diminish interest-sensitive expenditures. 

A technological advance bs an improved manner of production     ordinarily arising from a new technique, machine, material, or energy resource, which permits a greater output to be produced with given quantities of labor and capital inputs. It increases full-employment output and may create shortfall unemployment during the period in which money wages are inflexible downward, depending on such things as the money wages are inflexible downward, depending on such things as the price sensitivity of aggregate output demand and whether the advance increases the demand for investment goods. It may increase the natural rate of unemployment somewhat in any event, since some of the workers who are displaced may be poorly suited for the new jobs which appear and thus may become structurally unemployed. 

A decline in the supply of oil (or other natural resource which combines with labor and capital in production) will reduce aggregate output and full-employment output and raise prices. The real wage will decline, money wages may rise, and a shortfall of aggregate demand may appear.

Expansions in income-maintenance programs tend to increase the natural rate of unemployment, since they reduce the burden of unemployment. Increased proportions of women and teenagers in the labor force produce a similar effect on the natural rate of unemployment, since these groups have higher than average natural unemployment rates. If conditions relating to aggregate demand for output are constant when these two types of disturbances occur, prices rise, since they reduce full-employment output relative to demand. Prices are bid upward by an expenditure gap.