Suggested languages for you: |
|

## All-in-one learning app

• Flashcards
• NotesNotes
• ExplanationsExplanations
• Study Planner
• Textbook solutions

# Aggregate Supply Save Print Edit
Economics
• Macroeconomics • Microeconomics When a single producer supplies a product, we calculate their output on the basis of equivalent demand. However, think of the larger picture: let’s say the national level of supply in your country. To understand this, we need to know the aggregate supply, which is the total national output produced in an economy over a given time. This explanation will take you through the aggregate supply, the changes in the short and long-run aggregate supply, and the interaction of aggregate demand and aggregate supply. Keen to find out more? Read on!

## Aggregate supply definition

Aggregate supply is a macroeconomic concept concerned with the total output of the whole economy.

We can define aggregate supply (AS) as follows:

• a measure of the total volume of goods and services produced in the economy over a given period.
• the total amount that producers in an economy are willing and able to supply at a given price level.

We can also understand aggregate supply in the short run and in the long run. The corresponding curves of supply are shaped differently over the short or the long term.

## Short-run aggregate supply (SRAS) curve

The short-run aggregate supply curve involves two important concepts: movement along the supply curve and shift through the aggregate supply in the short run.

### Movement along the short-run aggregate supply (SRAS) curve

Movement along the supply curve occurs when the overall price level at which the product is sold changes, whilst other factors like production costs, labour productivity, and technology remain constant.

Let’s assume that a UK perfume company has its production unit in the UAE. The sale price of the perfume is £100 and the production cost according to the contract is £30 for the next year. So the profit for the company is £70.

However, there is an overall surge of 1% in the UK price level, which also increases the selling prices of perfumes to £101. Since there is a contract for production at £30 for the next year, the production cost will remain the same. This will increase the profit margin for the UK perfume company by £1.

This would result in UK companies taking advantage of the price increase by temporarily increasing their supply, leading to a movement along the supply curve. Figure 1. Movements along the SRAS curve - StudySmarter.

Figure 1 shows movements along the short-run aggregate supply (SRAS) curve. If the price rises from P to P1 there will be a movement along the SRAS curve from point a to point b, leading to an increase in national output from Q to Q2. If the price falls from P to P2 there will be a movement along the SRAS curve from point a to point c, leading to a fall in national output from Q to Q1.

### Shift of the short-run aggregate supply (SRAS) curve

As we explained before, when talking about movement along the curve, the output price level is variable while the other factors stay constant. However, when there is a change in the other factors like the production costs, labour productivity, or technical progress, but the price level at which the product is sold is constant, we can see a shift in the aggregate supply curve. The shift in the curve can be to the left or to the right depending on the increase or decrease in the other factors.

The factors that affect the short-run aggregate supply in the economy include (but are not limited to):

- Price level

- Cost of labour

- Cost of raw materials

- The level of taxes and subsidies Figure 2. Shifts in the short-run aggregate supply - StudySmarter.

Figure 2 shows the shifts in the SRAS curve. If the curve shifts to the right from SRAS to SRAS1 the national output increases from Q to Q2. If the curve shifts to the left from SRAS to SRAS2 the national output decreases from Q to Q1. Note that the price level remains constant as it is not a determinant of aggregate supply.

Let’s say that the price at which the UK perfume is sold remains unchanged at £100. However, the cost of production decreases to £25 due to a higher supply of labour at a low wage rate in the short run. The company decides to take advantage of this decrease and increases the production, hence increasing the supply in the economy. This results in the supply curve shifting to the right.

On the other hand, if the production cost increases to £40 due to lower employment number or an increase in material costs, the profit margin decreases to £60. Hence, the supplier will decrease the supply. This will result in the aggregate supply curve shifting to the left.

 The short-run aggregate supply curve(SRAS) Price Other factors(production costs, labour productivity, technology, etc.) Movement Changes Constant Shift Constant Change

Table 1. Comparison between the movements and shifts in short-run aggregate supply.

## Long-run aggregate supply (LRAS) curve

The long-run aggregate supply is based on the idea that firms have achieved equilibrium in the long run and they are producing at their full capacity. We also assume that all other factors are used in their full capacity.

### Position of the long-run aggregate supply (LRAS) curve

In the long run, we assume that the aggregate supply curve is vertical even if the price fluctuates as we also assume that the economy is running at its full capacity. The LRAS is vertical in the long run. Figure 3. Long-run aggregate supply curve - StudySmarter

### Shift of the long-run aggregate supply (LRAS) curve

The above concept is more theoretical. Over the long run, the other factors tend to improve and the aggregate supply can improve as well assuming the price level remains constant.

The factors that affect the long-run aggregate supply in the economy include (but are not limited to):

- The amount of capital and labour.

- Productivity of capital and labour.

- The quantity of land and raw materials.

- Technological improvements.

- Enterprise.

- Economic incentives.

There is always a scope for improvement. For example, technological changes can speed up production or increase the supply of raw materials which can result in the shift of the long-run supply curve to the right. Other factors such as increased labour supply, better government policies, training, and development of labour can also expedite production. These changes result in an increase in the supply, leading the supply curve to shift to the right without increasing the price.

Similarly, if the other factors deteriorate, the LRAS can shift to the left. Figure 4. A shift in the LRAS curve - StudySmarter.

Let’s examine the example of the milk supply in London. Even though the companies are producing at their full capacity and the price is not changing, there is a decrease in the number of truck drivers due to Brexit. Thus, the milk supply in the market was heavily affected and it was not reaching the end-users. This led to a decrease of milk supply in the market on a national level.

### Keynesian long-run aggregate supply (LRAS) curve

The Keynesian LRAS curve is different from the classical LRAS curve as Keynesians argue that the aggregate supply is elastic and upward sloping in the long run.

In the short run, there is scope for further production. This means production can be increased without much of an increase in price. This results in a horizontal aggregate supply curve up to point Q as figure 5 below shows.

However, as the economy approaches full capacity, going forward the aggregate demand increases and pushes the prices up making the curve bend steep upward (between points b and c). This can be due to shortages in factors of production like raw material, labour, etc. which increases the prices.

Eventually, when all hindrances are surpassed, the economy reaches its full potential to produce, and supply at its full capacity, the LRAS curve becomes vertical (from point c to point d and above). Figure 5. Keynesian LRAS curve - StudySmarter.

## What are the factors that determine aggregate supply?

The main determinants that influence the aggregate supply are:

1. Price level. One of the main factors that affect the aggregate supply is the price level of the product. For example, the higher the price level, the supplier will be willing to produce more and supply more.
2. Time. Aggregate supply curves behave differently over the short run and the long run. In the short run, capital is often fixed, whilst in the long run, all the factors of production are variable.
3. Employer wages can increase or decrease the overall aggregate supply. If the wages increase, the cost of production increases. Hence, the curve will shift to the left. If the wages reduce, the cost of supply decreases shifting the curve to the right
4. Technological changes that affect production can determine as well the aggregate supply over the long run and lead to higher or decreased aggregate supply in the economy.
5. Inflation and deflation can also affect the aggregate supply in the market. If there is inflation, the production costs may rise to lead to a lower aggregate supply.
6. Government policies play an important role in the overall supply as they may increase or decrease the production price due to the effects of taxes and subsidies.
7. Availability of resources. If the firms want to increase the production, but don’t have enough raw material or labour, they will not be able to produce which will shift the aggregate supply.

## Interaction of the aggregate demand and aggregate supply curves

Interaction between aggregate demand and aggregate supply curves is very important in macroeconomics.

### Aggregate Supply: Macroeconomics equilibrium

Macroeconomics equilibrium occurs when the aggregate demand curve and aggregate supply curve meet. The change in any of the curves results in a change in equilibrium.

### Increase in aggregate demand (AD) and output

The increase in aggregate demand (AD) affects the aggregate supply curve differently for short-run and long-run aggregate supply as the SRAS is upward sloping and LRAS is vertical.

In the short run, as the aggregate demand increases, the aggregate supply increases too at the higher price. The increased supply results in the movement along the SRAS curve to the right.

However, in the case of long-run aggregate supply, the output remains unchanged even when the aggregate demand increases. Even at the higher price level, the LRAS curve remains stagnant and vertical as the firm is producing at full capacity.

### Aggregate Supply: Limitations of the multiplier effect

The multiplier effect is the chain effect of the aggregate demand and aggregate supply. As more capital is injected into the economy, income increases resulting in an increase in aggregate demand and thus in the national output. However, this multiplier effect has certain limitations:

• If the consumer's goods and services are not adequately available, the income will not be spent and will not help in the multiplier effect.

• If the rotation of money in the economy is not continuous and if the investments stop, it can limit the multiplier effect.

• Open trade relations can also affect the multiplier effect and can make the multiplier larger or smaller than its true value.

• For the multiplier effect to work efficiently, it is assumed that employment is not at full capacity. Otherwise, it can lower the multiplier effect.

### The shift in the aggregate supply curve and its effects

The shifts in aggregate supply affect all the major factors in the macroeconomy over the short run and long run. It can have the following effects on all the main factors determining the national output:

• Increased or decreased capacity.

• Increased or decreased output.

• Increased or decreased economic growth.

• Increased or reduced employment.

## Output gaps, aggregate demand and aggregate supply

The output gap can be understood as the difference between the potential output (trend) and the actual output in the economy.

An output gap can also be understood using AD and AS.

We determine the equilibrium using the LRAS and AD1 (at point e).

When the SRAS1 is below the actual output and aggregate demand meets the SRAS1, it is below the equilibrium. This creates a negative output gap (at point a).

When the SRAS is above the actual output and the aggregate demand also increases above the equilibrium, it creates more supply. This creates a positive output gap (at point b). Figure 6. Negative and positive output gaps - StudySmarter.

## Aggregate Supply - Key takeaways

• The aggregate supply (AS) is a measure of the total volume of goods and services produced in the economy over a given time.
• The aggregate supply behaves differently over the short run and long run and its curves changes accordingly.
• The factors that affect the aggregate supply curves are price, time, employer wages, technological changes, inflation and deflation, government policies, and availability of resources.
• Macroequilibrium is when the aggregate demand meets the aggregate supply.
• The output gap occurs when the actual output is different from the potential output.

## Aggregate Supply

Aggregate supply is a measure of the total volume of goods and services produced in the economy over a given time.

The determinants of aggregate supply mainly affect the production side of the economy and include: costs of production, labour productivity, technical progress, and others.

When there is a change in the factors that affect the supply-side of the economy like production costs, labour productivity, technical progress, and others.

The two types of aggregate supply are:

• Short-run aggregate supply.
• Long-run aggregate supply.

To draw the aggregate supply curve you have to take into account other factors like the short or long run because those factors change the curves.

## Final Aggregate Supply Quiz

Question

What is aggregate supply?

Aggregate supply (AS) is a measure of the total volume of goods and services produced in the economy over a given time period.

Show question

Question

Name two types of aggregate supply.

Short-run and Long-run

Show question

Question

What remains constant in the movement along the aggregate supply curve?

Other factors

Show question

Question

What changes in the shift of the aggregate supply curve?

Other factors

Show question

Question

Which is the vertical aggregate supply curve?

The long-run aggregate supply curve

Show question

Question

Who suggested the other concept of LRAS?

Keynesians.

Show question

Question

When does macroeconomic equilibrium occur?

Macroeconomic equilibrium occurs when aggregate demand meets aggregate supply.

Show question

Question

How can we determine the output gap?

The output gap is the difference between the actual output and the potential or trend output.

Show question

Question

What are the types of the output gap?

1. Positive output gap
2. Negative output gap

Show question

Question

What is a positive output gap?

A positive output gap occurs when the actual output is above the potential or trend output.

Show question

Question

What is a negative output gap?

A negative output gap occurs when the actual output is below the potential or trend output.

Show question

Question

What is macroeconomic equilibrium?

Macroeconomic equilibrium occurs at the point where the aggregate demand meets the aggregate supply.

Show question

Question

Macroeconomics equilibrium is the same in the short run and the long run.

False

Show question

Question

How can we determine the macroeconomic equilibrium?

The macroeconomic equilibrium occurs at the point where aggregate demand meets aggregate supply.

Show question

Question

State some factors that may shift the AD and AS curves.

• Government policy

• Available resources

• Inflation or deflation

• Tax

• Wages.

Show question

Question

Explain the negative demand shock.

A negative demand shock is when the aggregate demand reduces due to reduced spending, lesser stock, etc. and the AD curve shifts to the left reducing the price and output.

Show question

Question

Explain the positive demand shock.

A positive demand shock is when the aggregate demand increases due to increased spending, higher stock, better output, etc. and the AD Curve shifts to the right increasing the price level and output.

Show question

Question

What is a positive supply shock?

A positive supply shock occurs when the aggregate quantity supplied increases in the short-run due to the reduction in production cost or increased labour, technology advancement which results in the AS to shift in the right.

Show question

Question

What is a negative supply shock?

A negative supply shock is when the aggregate supply reduces over the short run and the SRAS curve shifts to the left leading to an increase in price level and a decrease in the supply in the economy.

Show question

Question

Explain the macroeconomic equilibrium equation.

Y = Aggregate income = Macroeconomics equilibrium

C = consumption

I = Investment

G = Government expenditure

Therefore, the equation will be

Y = C+I+G

Show question

Question

Name the three types of macroeconomic equilibrium.

• The full employment equilibrium
• The recessionary gap
• The inflationary gap

Show question

Question

What is the full-employment equilibrium?

When all the available resources are fully utilised the potential output is equal to actual output and when there is no excess of deficit in the demand, this is when we say the economy has achieved full employment equilibrium.

Show question

Question

What is the recessionary gap?

The recessionary gap occurs when the actual output is less than the potential output taking into consideration the aggregate demand and short-run aggregate supply and also long run aggregate supply.

Show question

Question

What is the inflationary gap?

When the actual output is greater than the potential output, we see the positive output gap, which is also known as the inflationary gap.

Show question

Question

How can we get a long-run aggregate supply curve?

LRAS is when the economy produces to its maximum potential level to meet the aggregate demand in an economy.

Show question

Question

What will increase macroeconomic equilibrium prices?

A negative supply shock is when the aggregate supply reduces over a short run and the SRAS curve shifts to the left leading to the increase in price level and decrease in the supply in the economy.

Show question 60%

of the users don't pass the Aggregate Supply quiz! Will you pass the quiz?

Start Quiz

### No need to cheat if you have everything you need to succeed! Packed into one app! ## Study Plan

Be perfectly prepared on time with an individual plan. ## Quizzes

Test your knowledge with gamified quizzes. ## Flashcards

Create and find flashcards in record time. ## Notes

Create beautiful notes faster than ever before. ## Study Sets

Have all your study materials in one place. ## Documents

Upload unlimited documents and save them online. ## Study Analytics

Identify your study strength and weaknesses. ## Weekly Goals

Set individual study goals and earn points reaching them. ## Smart Reminders

Stop procrastinating with our study reminders. ## Rewards

Earn points, unlock badges and level up while studying. ## Magic Marker

Create flashcards in notes completely automatically. ## Smart Formatting

Create the most beautiful study materials using our templates.