When aggregate supply is positively sloped and there is a decrease in the mark-up on variable cost, aggregate supply shifts to the :

Question

Accepted Answer

The correct option is 2:
Right, the price level falls and output increases.

In macroeconomics, the Short-Run Aggregate Supply (AS) curve is generally determined by the costs of production. Firms often set prices based on their variable costs (like wages) plus a mark-up for profit. The equation is typically represented as Price = (1 + $\mu$) * Marginal Cost, where $\mu$ is the mark-up rate. A decrease in the mark-up ($\mu$) means firms are charging less for the same level of variable cost, effectively reducing the overall cost of production for every level of output. When production costs fall, firms are willing to supply a larger quantity of goods and services at any given price level. This positive supply shock causes the AS curve to shift outwards, or to the right. In the context of the Aggregate Demand (AD) and AS model, a rightward shift of the AS curve leads to a new equilibrium point where the price level is lower (disinflationary effect) and the real output (GDP) is higher, resulting in increased economic activity.

The incorrect option is 1:
Left, the price level falls and output increases. A leftward shift of the AS curve signifies an increase in production costs (a negative supply shock), which would typically lead to a fall in output and a rise in the price level (stagflation), not a fall in the price level and an increase in output.

The incorrect option is 3:
Left, the price level increases and output decreases. This outcome describes a negative supply shock, such as an increase in variable costs or an *increase* in the mark-up, which contracts the AS curve. A decrease in the mark-up has the opposite effect, making production cheaper.

The incorrect option is 4:
Right, the price level increases and output decreases. A rightward shift of the AS curve correctly reflects the decrease in the mark-up, but this shift causes the price level to *fall* and output to *increase*. This option incorrectly states the resulting equilibrium effects on price and output.