Question

If there is an increase in productivity, show what happens to output level, price level and the unemployment rate in the long run? (Use AD-AS model)

Answer 1

If there is increase in productivity, producers will be able to produce more goods at lesser inputs which will help them in producing more goods which will raise aggregate supply of goods and shift aggregate supply curve to its right from AS to AS1 while aggregate deman remains the same. It will reduce the price from P to P1 and output level to rise from Q to Q1 in short run which will shift the economic equilibrium from point E to E1.

In long run, consumers will demand more of the goods because price is less now. It will raise aggregate demand curve to its right from AD to AD1 which will raise the price to its initial level of P while output level rises further to Q2. In long run, unemployment level will fall because rise in output induce producers to hire more labor.