Unlike changes in aggregate demand, a change in aggregate supply can be relatively challenging to assess when considering the goal of full employment. This is because an increase in aggregate supply will not necessarily lead to a decrease in the rate of unemployment.
To make this clear, we will consider two different examples. First, imagine a situation in which interest rates payable by businesses fell. At this time, businesses would not need to commit as much of their money to finance the debt that they are carrying. This may lead to an increase in aggregate supply.
The increase in quantity that results may be produced due to an increase in employment. This is because businesses now have lower costs, and so they may be willing to use more of the remaining revenue to employ people.
However, now consider the impact of an increase in productivity. At times like this, business owners will find that their existing employees are more able to produce the quantity of goods and services that they require. As such, the increase in aggregate supply may not equate to an increase in employment. In fact, unemployment can increase if some people do not gain the necessary skills to improve their productivity, or if productivity gains are made through the introduction of technology.
As such, it is important that we recognise what type of supply factor we are looking at before assessing the impact. In general terms, we can say that any supply factor which will lead to a decrease in costs may encourage an improvement in the labour market. On the other hand, any improvements in efficiency will need to be considered more carefully.
We should also consider one very specific example. When the participation rate increases we are experiencing an increase in the availability of resources – the labour resource. This can lead to an increase in aggregate supply. However, it can also lead to an increase in the unemployment rate. Imagine that a hypothetical economy has only 100 people in the population. Of that group, 60 people are in the labour force. From that group of 60, six people are unable to find work. In this case, the unemployment rate would be 10%.
Now, imagine that three more people decide to enter the labour force. In the first instance, these people are not able to find jobs, as they have just arrived in the labour market. Therefore, the labour force will increase to 63, and the number of unemployed will increase to nine people. The unemployment rate now is 14.3% - it has increased despite the fact that we have experienced an increase in aggregate supply due to the availability of the labour resource.
| Population | Labour Force | Participation Rate | Unemployed | Unemployment Rate | |
| Option 1 | 100 | 60 | 60% | 6 | 10% |
| Option 2 | 100 | 63 | 63% | 9 | 14.3% |
Being able to complete these calculations will certainly help you to gain marks on the final exam. If you have any doubt at all, refer to the labour market diagram that is available earlier in this section. If you are familiar with that diagram, you will always be able to calculate both the unemployment rate and the participation rate with ease.