Boundless Economics

Aggregate Demand and Supply

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

KEY TAKEAWAYS

Key Points

Aggregate supply is the relationship between the price level and the
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 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: Y = Y* + α(P-Pe). 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: Y

= Y*. In the equation, Y is the production of the economy and Y* is
the natural level of production of the economy.

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.

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.
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 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: Y = Y* + α(P-Pe). 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.
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 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: 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

KEY TAKEAWAYS

Key Points

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

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 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.

Key Terms

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.

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
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 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: Y = Y* + α(P-Pe). 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.
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 Classical
Price level

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Keynesian

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Real GDP
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
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 KEY TAKEAWAYS

Key Points

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: Y =

Y*. In the equation, Y is the level of economic production and Y* is
the natural level of production.

Key Terms

long-run: The conceptual time period in which there are no fixed

factors of production.

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
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 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.

Classical
Price level

te
ia
ed
m r

Keynesian
te
In

Real GDP
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
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 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: 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

KEY TAKEAWAYS

Key Points
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 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.

Key Terms

capital: Already-produced durable goods available for use as a

factor of production, such as steam shovels (equipment) and office
buildings (structures).

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.
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 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.

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

KEY TAKEAWAYS
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 Key Points

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

short-run: When one or more factors are fixed.

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.
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 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: Y = Y*
+ α(P-Pe). 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.

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.
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