Decrease in Aggregate Supply - Keynesian
When aggregate supply falls the supply curve shifts to the left. Here a Keynesian aggregate supply curve is shown.
Keynesians believe that the aggregate supply curve will be the same in the short and long run, and so a decrease in aggregate supply will shift the edge of the curve to the left. This may be caused by a change in productivity, changes in the tax and benefit system or some other factor affecting the amount of output that can be produced in the economy.
Change in Aggregate Supply - Shift Left
If the aggregate supply curve shifts to the left the equilibrium level of income will fall and there will be an increase in the price level in the economy.
A leftward shift in the aggregate supply curve may be caused by a variety of factors. One possible reason may be an increase in the level of costs in the economy. If there is a persistent change in costs then "cost-push inflation" may result.
Aggregate Demand and Supply - Classical
Classical economists believe that in the short run the aggregate supply curve will slope upwards, but in the long run will be vertical. Equilibrium will be where aggregate demand equals supply.
In the short run it is possible for the economy to expand beyond full employment, but this will cause the price level to rise and in the long run the economy will return automatically to full employment, but at a higher price level. This results in a vertical long run aggregate supply curve.
Decrease in Short Run Aggregate Supply
A decrease in aggregate supply will shift the curve left. Classical economists believe that the level of aggregate supply may change in the short run, but the long run aggregate supply curve will be vertical.
A decrease in aggregate supply may be caused by any factors that reduce the potential level of output that can be produced by the economy. Possibilities include a reduction in productivity, increased tax rates reducing the incentive to work or perhaps a fall in the level of education.
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