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24.4: Aggregate Supply

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    Introducing Aggregate Supply

    Aggregate supply is the total supply of goods and services that firms in a national economy plan to sell during a specific time period.

    Learning objectives
    • Define Aggregate Supply

    Aggregate Supply

    In economics, aggregate supply is the total supply of goods and services that firms in a national economy plan to sell during a specific time period. It is the total amount of goods and services that the firms are willing to sell at a given price level in the economy. Aggregate supply is the relationship between the price level and the production of the economy.

    te-demand-aggregate-supply.jpg

    Aggregate Supply: Aggregate supply is the total quantity of goods and services supplied at a given price. Its intersection with aggregate demand determines the equilibrium quantity supplied and price.

    Short-run Aggregate Supply

    In the short-run, the aggregate supply is graphed as an upward sloping curve. The equation used to determine the short-run aggregate supply is: \(\mathrm{Y = Y^* + α(P-P_e)}\). In the equation, Y is the production of the economy, Y* is the natural level of production of the economy, the coefficient α is always greater than 0, P is the price level, and Pe is the expected price level from consumers.

    The short-run aggregate supply curve is upward sloping because the quantity supplied increases when the price rises. In the short-run, firms have one fixed factor of production (usually capital ). When the curve shifts outward the output and real GDP increase at a given price. As a result, there is a positive correlation between the price level and output, which is shown on the short-run aggregate supply curve.

    Long-run Aggregate Supply

    In the long-run, the aggregate supply is graphed vertically on the supply curve. The equation used to determine the long-run aggregate supply is: \(\mathrm{Y = Y^*}\). In the equation, Y is the production of the economy and Y* is the natural level of production of the economy.

    The long-run aggregate supply curve is vertical which reflects economists’ beliefs that changes in the aggregate demand only temporarily change the economy’s total output. In the long-run, only capital, labor, and technology affect aggregate supply because everything in the economy is assumed to be used optimally. The long-run aggregate supply curve is static because it is the slowest aggregate supply curve.

    The Slope of the Short-Run Aggregate Supply Curve

    In the short-run, the aggregate supply curve is upward sloping.

    Learning objectives
    • Summarize the characteristics of short-run aggregate supply

    Aggregate Supply

    Aggregate supply is the total supply of goods and services that firms in a national economy plan to sell during a specific period of time. It is the total amount of goods and services that firms are willing to sell at a given price level.

    Short-run Aggregate Supply Curve

    In the short-run, the aggregate supply curve is upward sloping. There are two main reasons why the quantity supplied increases as the price rises:

    1. The AS curve is drawn using a nominal variable, such as the nominal wage rate. In the short-run, the nominal wage rate is fixed. As a result, an increasing price indicates higher profits that justify the expansion of output.
    2. An alternate model explains that the AS curve increases because some nominal input prices are fixed in the short-run and as output rises, more production processes encounter bottlenecks. At low levels of demand, large numbers of production processes do not make full use of their fixed capital equipment. As a result, production can be increased without much diminishing returns. The average price level does not have to rise much in order to justify increased production. In this case, the AS curve is flat. Likewise, when demand is high, there are few production processes that have unemployed fixed outputs. Any increase in demand production causes the prices to increase which results in a steep or vertical AS curve.

    Short-run Aggregate Supply Equation

    The equation used to calculate the short-run aggregate supply is: \(\mathrm{Y = Y^* + α(P-P_e)}\). In the equation, Y is the production of the economy, Y* is the natural level of production, coefficient is always positive, P is the price level, and Pe is the expected price level.

    In the short-run, firms possess fixed factors of production, including prices, wages, and capital. It is possible for the short-run supply curve to shift outward as a result of an increase in output and real GDP at a given price. As a result, the short-run aggregate supply curve shows the correlation between the price level and output.

    aggregate-supply.png

    Aggregate Supply Curve: This graph shows the aggregate supply curve. In the short-run the aggregate supply curve is upward sloping. When the curve shifts outward, it is due to an increase in output and real GDP.

    The Slope of the Long-Run Aggregate Supply Curve

    The long-run aggregate supply curve is perfectly vertical; changes in aggregate demand only cause a temporary change in total output.

    Learning objectives
    • Assess factors that influence the shape and movement of the long run aggregate supply curve

    Aggregate Supply

    In economics, aggregate supply is defined as the total supply of goods and services that firms in a national economy are willing to sell at a given price level.

    Long-run in Economics

    The long-run is the conceptual time period in which there are no fixed factors of production; all factors can be changed. In the long-run, firms change supply levels in response to expected economic profits or losses.

    Long-run Aggregate Supply Curve

    In the long-run, only capital, labor, and technology affect the aggregate supply curve because at this point everything in the economy is assumed to be used optimally. The long-run aggregate supply curve is static because it shifts the slowest of the three ranges of the aggregate supply curve. The long-run aggregate supply curve is perfectly vertical, which reflects economists’ belief that the changes in aggregate demand only cause a temporary change in an economy’s total output. In the long-run, there is exactly one quantity that will be supplied.

    aggregate-supply.png

    Aggregate Supply: This graph shows the aggregate supply curve. In the long-run the aggregate supply curve is perfectly vertical, reflecting economists’ belief that changes in aggregate demand only cause a temporary change in an economy’s total output.

    The long-run aggregate supply curve can be shifted, when the factors of production change in quantity. For example, if there is an increase in the number of available workers or labor hours in the long run, the aggregate supply curve will shift outward (it is assumed the labor market is always in equilibrium and everyone in the workforce is employed). Similarly, changes in technology can shift the curve by changing the potential output from the same amount of inputs in the long-term.

    For the short-run aggregate supply, the quantity supplied increases as the price rises. The AS curve is drawn given some nominal variable, such as the nominal wage rate. In the short run, the nominal wage rate is taken as fixed. Therefore, rising P implies higher profits that justify expansion of output. However, in the long run, the nominal wage rate varies with economic conditions (high unemployment leads to falling nominal wages — and vice-versa).

    The equation used to calculate the long-run aggregate supply is: \(\mathrm{Y = Y^*}\). In the equation, Y is the level of economic production and Y* is the natural level of production.

    Moving from Short-Run to Long-Run

    In the short-run, the price level of the economy is sticky or fixed; in the long-run, the price level for the economy is completely flexible.

    Learning objectives
    • Recognize the role of capital in the shape and movement of the short-run and long-run aggregate supply curve

    In economics, the short-run is the period when general price level, contractual wages, and expectations do not fully adjust. In contrast, the long-run is the period when the previously mentioned variables adjust fully to the state of the economy.

    Aggregate Supply

    Aggregate supply is the total amount of goods and services that firms are willing to sell at a given price level.

    When capital increases, the aggregate supply curve will shift to the right, prices will drop, and the quantity of the good or service will increase.

    Short-run Aggregate Supply

    During the short-run, firms possess one fixed factor of production (usually capital). It is possible for the curve to shift outward in the short-run, which results in increased output and real GDP at a given price. In the short-run, there is a positive relationship between the price level and the output. The short-run aggregate supply curve is an upward slope. The short-run is when all production occurs in real time.

    te-demand-aggregate-supply.jpg

    Aggregate Supply: This graph shows the relationship between aggregate supply and aggregate demand in the short-run. The curve is upward sloping and shows a positive correlation between the price level and output.

    Long-run Aggregate Supply

    In the long-run only capital, labor, and technology impact the aggregate supply curve because at this point everything in the economy is assumed to be used optimally. The long-run supply curve is static and shifts the slowest of all three ranges of the supply curve. The long-run curve is perfectly vertical, which reflects economists’ belief that changes in aggregate demand only temporarily change an economy’s total output. The long-run is a planning and implementation stage.

    Moving from Short-run to Long-run

    In the short-run, the price level of the economy is sticky or fixed depending on changes in aggregate supply. Also, capital is not fully mobile between sectors.

    In the long-run, the price level for the economy is completely flexible in regards to shifts in aggregate supply. There is also full mobility of labor and capital between sectors of the economy.

    The aggregate supply moves from short-run to long-run when enough time passes such that no factors are fixed. That state of equilibrium is then compared to the new short-run and long-run equilibrium state if there is a change that disturbs equilibrium.

    Reasons for and Consequences of Shifts in the Short-Run Aggregate Supply Curve

    The short-run aggregate supply shifts in relation to changes in price level and production.

    Learning objectives
    • Identify common reasons for shifts in the short-run aggregate supply curve, Explain the consequences of shifts in the short-run aggregate supply curve

    Aggregate Supply

    The aggregate supply is the relation between the price level and production of an economy. It is the total supply of goods and services that firms in a national economy plan on selling during a specific time period at a given price level.

    Short-run Aggregate Supply

    In the short-run, the aggregate supply curve is upward sloping because some nominal input prices are fixed and as the output rises, more production processes experience bottlenecks. At low levels of demand, production can be increased without diminishing returns and the average price level does not rise. However, when the demand is high, few production processes have unemployed fixed inputs. Any increase in demand and production increases the prices. In the short-run, the general price level, contractual wage rates, and expectations many not fully adjust to the state of the economy.

    Shifts in the Short-run Aggregate Supply

    The short-run aggregate supply shifts in relation to changes in price level and production. The equation used to determine the short-run aggregate supply is: \(\mathrm{Y = Y^*}\). Y is the production of the economy, Y* is the natural level of production, coefficient α is always positive, P is the price level, and Pe is the expected price level.

    In the short-run, examples of events that shift the aggregate supply curve to the right include a decrease in wages, an increase in physical capital stock, or advancement of technology. The short-run curve shifts to the right the price level decreases and the GDP increases. When the curve shifts to the left, the price level increases and the GDP decreases.

    Any event that results in a change of production costs shifts the short-run supply curve outwards or inwards if the production costs are decreased or increased. Factors that impact and shift the short-run curve are taxes and subsides, price of labor (wages), and the price of raw materials. Changes in the quantity and quality of labor and capital also influence the short-run aggregate supply curve.

    as-2b-ad-graph.png

    Short-run Aggregate Supply: This graph shows the Aggregate Suppy-Aggregate Demand model. In regards to aggregate supply, increases or decreases in the price level and output cause the aggregate supply curve to shift in the short-run.

    Key Points

    • Aggregate supply is the relationship between the price level and the production of the economy.
    • In the short-run, the aggregate supply is graphed as an upward sloping curve.
    • The short-run aggregate supply equation is: \(\mathrm{Y = Y^* + α(P-P_e)}\). In the equation, Y is the production of the economy, Y* is the natural level of production of the economy, the coefficient α is always greater than 0, P is the price level, and Pe is the expected price level from consumers.
    • In the long-run, the aggregate supply is graphed vertically on the supply curve.
    • The equation used to determine the long-run aggregate supply is: \(\mathrm{Y = Y^*}\). In the equation, Y is the production of the economy and Y* is the natural level of production of the economy.
    • The AS curve is drawn using a nominal variable, such as the nominal wage rate. In the short-run, the nominal wage rate is fixed. As a result, an increasing price indicates higher profits that justify the expansion of output.
    • The AS curve increases because some nominal input prices are fixed in the short-run and as output rises, more production processes encounter bottlenecks.
    • In the short-run, the production can be increased without much diminishing returns. The average price level does not have to rise much in order to justify increased production. In this case, the AS curve is flat.
    • When demand is high, there are few production processes that have unemployed fixed outputs. Any increase in demand production causes the prices to increase which results in a steep or vertical AS curve.
    • The long-run is a planning and implementation phase. It is the conceptual time period in which there are no fixed factors of production.
    • In the long-run, only capital, labor, and technology affect the aggregate supply curve because at this point everything in the economy is assumed to be used optimally.
    • Aggregate supply is usually inadequate to supply ample opportunity. Often, this is fixed capital equipment. The AS curve is drawn given some nominal variable, such as the nominal wage rate.
    • In the long run, the nominal wage rate varies with economic conditions (high unemployment leads to falling nominal wages — and vice-versa).
    • The equation used to calculate the long-run aggregate supply is: \(\mathrm{Y = Y^*}\). In the equation, Y is the level of economic production and Y* is the natural level of production.
    • When capital increases, the aggregate supply curve will shift to the right, prices will drop, and the quantity of the good or service will increase.
    • The short-run aggregate supply curve is an upward slope. The short-run is when all production occurs in real time.
    • The long-run curve is perfectly vertical, which reflects economists’ belief that changes in aggregate demand only temporarily change an economy’s total output. The long-run is a planning and implementation stage.
    • Aggregate supply moves from short-run to long-run by considering some equilibrium that is the same for both short and long-run when analyzing supply and demand. That state of equilibrium is then compared to the new short-run and long-run equilibrium state from a change that disturbs equilibrium.
    • In the short-run, the aggregate supply curve is upward sloping because some nominal input prices are fixed and as the output rises, more production processes experience bottlenecks.
    • At low levels of demand, production can be increased without diminishing returns and the average price level does not rise.
    • When the demand is high, few production processes have unemployed fixed inputs. Any increase in demand and production increases the prices.
    • Any event that results in a change of production costs shifts the short-run supply curve outwards or inwards if the production costs are decreased or increased.

    Key Terms

    • factor of production: A resource employed to produce goods and services, such as labor, land, and capital.
    • output: Production; quantity produced, created, or completed.
    • supply: The amount of some product that producers are willing and able to sell at a given price, all other factors being held constant.
    • aggregate: A mass, assemblage, or sum of particulars; something consisting of elements but considered as a whole.
    • long-run: The conceptual time period in which there are no fixed factors of production.
    • capital: Already-produced durable goods available for use as a factor of production, such as steam shovels (equipment) and office buildings (structures).
    • short-run: When one or more factors are fixed.

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