Aggregate Supply

About aggregate supply 

Aggregate supply (AD) is the total supply of final goods and services companies produce and plan to sell at a certain price within a specific time. In other words, aggregate supply is the economy’s real gross domestic product (GDP).

A shift in aggregate supply is determined by a number of variables. They include:

• Changes in size and quality of labour

• Technological innovations

• Changes in capital investment and production costs

• Changes in producer taxes and subsidies

Short-run aggregate supply (SRAS)

• SRAS is an upward-sloping AS curve, suggesting a positive relationship between the price level and the quantity of goods and services.

• In the short run, capital (e.g. machinery, building, infrastructure) is fixed, and firms respond to higher demand by deploying existing capital more intensively, such as getting workers to do overtime.

Movement Along the SRAS Curve

Movement along the Aggregate Supply (AS) curve occurs when there is a change in the price level, caused primarily by shifts in aggregate demand (AD), while all other factors affecting aggregate supply (such as technology, input costs, or labour availability) remain constant.

Shifts of the SRAS Curve

A shift in the SRAS curve occurs when factors other than the price level change, affecting the ability or willingness of firms to supply goods and services at every price level.

Several factors can cause the SRAS curve to shift, including:

• Input prices

• Changes in productivity

• Supply shocks

• Government policies and regulations

• Expectations of future prices

Increase in aggregate supply (AS)

A rightward shift of the SRAS curve means that firms can produce more output at every price level because of the following factors:

• Lower input costs (e.g. cheaper materials or energy)

• Improvements in technology or worker productivity

• Positive supply shocks (e.g. new resource discoveries)

• Reduced tax and regulations

• Increased subsidies

Decrease in aggregate supply (AS)

 Similarly, a leftward shift of the SRAS curve means that firms produce less output at every price level due to the following factors:

• Higher input costs (e.g. increased wages or raw material prices)

• Declining productivity (e.g. due to outdated technology or inefficient processes)

• Negative supply shocks (e.g. natural disasters or disruptions in supply chains)

• Increased regulations or taxes

Long-run aggregate supply (LRAS)

Long-run aggregate supply (LRAS) refers to the total quantity of goods and services that an economy can produce when all factors of production (labor, capital, technology, natural resources) are fully utilised and operating at their most efficient levels.

Classic view of long-run aggregate supply (LRAS)

The classic view suggests that the LRAS curve is vertical because the economy’s output is determined by its fundamental productive capacity, operates at full employment and is independent of price changes. Hence, in the long-term view, changes in the price level will not affect the total output (real GDP) as the economy has reached its maximum level of production.

Keynesian view of long-run aggregate supply (LRAS)

Keynesians believe the long-run aggregate supply can be upward-sloping and horizontal over different ranges of output.

• They argue that during the recession phase, the economy operates below full employment, and there is significant spare capacity. Since firms can increase the output without raising prices, the LRAS curve is horizontal.

• As the economy nearly approaches full capacity, resources start becoming scarcer. In this immediate phase, an increase in aggregate demand will lead to both higher output and rising prices as firms have to bid up wages and other input costs to attract scarce resources. The LRAS curve is upward-sloping.

• Once the economy reaches full employment and maximum capacity, further increases in aggregate demand only result in inflation, not higher output. Therefore, the LRAS curve is vertical in this phase.

References

Brown, T & Foreman, C 2022, UH Macroeconomics 2022, OpenStax, Houston, TX, pp. 457-527.

Econlib n.d., Aggregate Supply, Econlib, available at <https://www.econlib.org/library/Topics/College/aggregatesupply.html>.

Jahan, S, Mahmud, A.S & Papageorgiou, C 2014, Back to Basics: What Is Keynesian Economics?, Finance & Development, vol. 51, no. 3, International Monetary Fund (IMF), available at <https://www.imf.org/external/pubs/ft/fandd/2014/09/basics.htm>.

Reserve Bank of Australia n.d., Economic Growth, Reserve Bank of Australia, available at <https://www.rba.gov.au/education/resources/explainers/economic-growth.html>.

Sean, M 2024, Aggregate Supply, Inomics, available at <https://inomics.com/terms/aggregate-supply-1541332>.