What is Aggregate Supply?
Aggregate supply represents the total supply of products that companies produce and plan to sell at a certain price within a specific period. Simply put, it refers to the finished goods that consumers purchase during a specified time. Aggregate supply is typically represented by an upward-sloping curve, showing a positive relationship between supply and price levels.
Key Insights
- Aggregate supply is the total amount of goods and services produced at a specific price point during a particular period.
- Short-term changes in aggregate supply are primarily influenced by fluctuations in demand.
- Technological advancements and other industry changes significantly impact long-term aggregate supply.
- Aggregate supply contrasts with aggregate demand, which is the total demand for finished goods and services over a specified period.
Understanding Aggregate Supply
Aggregate supply refers to the total supply of final goods and services that companies plan to sell at certain price levels within a specific timeframe. It contrasts with the supply from a single producer, embodying the economy’s gross domestic product (GDP). Aggregate supply is measured over a year and often referred to as total output by economists and analysts.
Factors Influencing Aggregate Supply
The aggregate supply curve effects originated primarily due to changes in prices. Typically, rising prices indicate businesses should augment production to meet higher levels of aggregate demand. Factors leading to changes in aggregate supply include:
- Changes in the size and quality of labor
- Technological advancements
- Wage increases
- Production costs fluctuations
- Changes in producer taxes and subsidies
- Inflation levels
A surge in labor efficiency or technological advancements tends to boost supply, whereas increasing wages or production costs may weaken it.
Aggregate Supply Over Time
Short Run
In the short run, aggregate supply reacts to high demand and price by maximizing the use of current inputs in the production process. Since capital levels are fixed in short durations, companies ramp up supply by increasing existing resources’ utility.
Long Run
Long-term aggregate supply is driven by productivity and efficiency improvements, such as better worker skills, technological advancements, and increased capital. Economic theories like Keynesian economics propose that beyond a specific point, supply is price inelastic in the long term.
Aggregate Supply vs. Aggregate Demand
Aggregate supply contrasts with aggregate demand, representing the total domestic demand for finished goods and services within a period, often expressed in dollar terms. Factors such as interest rates, foreign exchange rates, inflation, and income levels typically affect aggregate demand.
Example of Aggregate Supply
Consider XYZ Corporation, which produces 100,000 widgets per quarter at a total cost of $1 million. If the critical component’s cost, contributing to 10% of the expense, doubles due to external factors, XYZ can only produce 90,909 widgets at the same production cost, reflecting decreased aggregate supply. Concurrently, due to higher production costs and lower supply, prices would likely increase.
What Is Aggregate Demand?
Aggregate demand is the total demand for all finished goods and services in the market over certain durations, reflected as prices paid by consumers for final products.
What Is the Law of Supply and Demand?
The law of supply and demand propounds that supply inclines with rising prices, while demand mounts with falling prices.
What Factors Affect Supply in the Economy?
Economic supply drivers include prices, production costs, the number of producers, technology, and labor market conditions.
The Bottom Line
Aggregate supply denotes the total output producers are willing to sell at certain prices during specified periods. Changes in aggregate supply influence demand and the economy’s functionality, guiding businesses and entities in their financial decisions, budgeting, and forward planning.
References
- University of Colorado, Boulder. “A Model of the Macro-Economy: Aggregate Demand and Supply”.
- Eastern Economic Journal. “Keynesian Theory and the Aggregate-Supply/Aggregate-Demand Framework: A Defense”.
