Aggregate Supply

In O Level Economics lessons, we learned that the ‘supply’ means willingness and ability of producers/suppliers to offer goods and services for sale. The quantity of goods and services supplied increases as the price goes up. Therefore, if we represent this in a diagram, the supply curve is upwards sloping.

If we add up the supply curves of all producers in the economy, we can develop an Aggregate Supply Curve(AS). Aggregate supply curve shows what happens to the total output of all the goods and services in the economy as the general price level changes. Just like individual supply curves, AS curve also slopes upwards because, producers as a whole will expand the amount they are willing to supply as prices rise. Therefore, AS represents the ability of an economy to deliver goods and services to meet demand.

The nature of this relationship will differ between the long run and the short run

Short Run Aggregate Supply (SRAS) shows total planned output when prices in the economy can change but the prices and productivity of all factor inputs e.g. wage rates and the state of technology are held constant.

In the short run, the Aggregate Supply curve reflects a positive relationship between the price level and the real quantity of National Output.
Aggregate-Supply-curve

This short-run positive relationship occurs primarily because production costs (e.g., wages) are “sticky” relative to output prices when demand changes. Increases to Aggregate Demand cause movements up along the Aggregate Supply curve in which prices rise more quickly than wages, so higher profit per unit induces more output. Declines in Aggregate Demand reverse these movements along the Aggregate Supply curve – prices fall more quickly than costs, so profits decline and firms reduce production.

Shifts of the short-run aggregate supply curve

AS and AD Curve
The short-run aggregate supply curve shifts under similar circumstances as individual supply curves.

So, anything that is able to change the factor costs will be a shift factor of Short-Run Aggregate Supply.

Shift Factor The change to AS Curve Reason
Increase in labour force or capital stock AS Curve will shift to its right More output can be produced at every price level
Increase in productivity AS Curve will shift to its right Fall in the unit costs of production
Increase in the expected future price level AS Curve will shift to its left Workers and firms increase wages and prices
Increase in government taxes AS Curve will shift to its left Costs increase

Long run aggregate supply (LRAS): LRAS shows total planned output when both prices and average wage rates can change – it is a measure of a country’s potential output and the concept is linked to the production possibility frontier.

In the long run, the LRAS curve is assumed to be vertical (i.e. it does not change when the general price level changes)

LRAS

Next topic: Determining the price level and equilibrium level of real output

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