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Supply side shocks

The level of national income can change in the short term if there is a supply-side shock. Many factors can bring about a sudden changes in supply, including changes in the following:

  1. Wage levels, which affect firms’ unit labour costs.

  2. Other costs of production, such as commodity prices, or which changes in oil prices are significant.

  3. Indirect taxes, such as VAT.

  4. Subsidies.

  5. Productivity of factors, especially labour.

  6. Changes in the use of technology and production methods.

  7. Direct taxes, such as income tax, via an incentive or disincentive effect.

  8. Length of the working week.

  9. Labour migration.


The effect of cost shocks

A cost shock will affect the aggregate supply curve in the short run, and the AS curve will shifts upwards and to the left.

Taking the example of a wage shock, the increase in wages will lead to a rise in business costs, which will shift the AS curve shift upwards, causing the price level will rise from P to P1.

This will cause a contraction of AD, and equilibrium will fall to Y1, resulting in a fall in real output and a probable loss of jobs. Therefore, cost shocks can result in serious economic difficulties for the affected country. Increases in oil prices are always a concern because of the general inflationary effects they can create.