The Relative Effects of Demand and Supply on Output Growth and Price Change

Abstract

This study demonstrates an analytical model for evaluating the relative importance of demand and supply factors in determining output growth and price change. Empirical analysis of the 1947-80 data shows that, for most industry groups, demand effects are more dominant in determining output growth, whereas supply effects are more dominant in determining price change. The conclusion remains the same when the effects of uncontrollable variables such as taste and technology are excluded. The study provides useful information for analyzing the effectiveness of demand and supply management policies in affecting output growth and price change. Introduction Recently the stability and validity of the Phillips Curve and the effectiveness of demand management policies to deal with stagflation have been questioned by many economists. Evidence has been accumulated, e.g., Eckstein (1984), to suggest that variations in aggregate supply price were the predominant influences on the general price level of the U.S. economy. But little is known about whether demand or supply factors were more dominant in determining economic growth. Studies on the relative importance of demand and supply factors at the industry level have been very few. But the recent studies by Houthakker (1979 and 1981) suggested the importance of supply shifts and/or economies of