Aggregate supply

Aggregate Supply

Definition

  • Aggregate supply is the total quantity of goods and services that producers in an economy are willing and able to supply at a given price level.
  • It shows the relationship between the nation’s overall price level, and the quantity of goods and services produced by that nation’s suppliers.

Short-run and Long-run Aggregate Supply

  • Short-run aggregate supply (SRAS): Varies with price level and is affected by costs of production like wages, taxes, and the prices of raw materials.
  • Long-run aggregate supply (LRAS): Represents the output that an economy can support at full employment over a period of time. It is considered to be vertical as it is independent of the price level in the long run.

Aggregate Supply Curve

  • The Aggregate Supply curve shows the level of real output that the firms will produce at each possible price level.
  • The SRAS curve is positively sloped, indicating a direct relation between the price level and real GDP.
  • The LRAS is vertical, demonstrating that the nation’s output is determined by factors such as workforce size and technology, not the price level.

Factors Affecting Aggregate Supply

  • Cost of production: Rise in wages or raw material prices reduce aggregate supply.
  • Productivity: Technological advancements can boost productivity and increase aggregate supply.
  • Government policies: Policies favouring businesses can boost aggregate supply.
  • Workforce and natural factors: Changes in these can directly affect the potential output of an economy.

Importance of Aggregate Supply

  • Aggregate Supply in tandem with Aggregate Demand helps to determine the actual level of an economy’s GDP and its overall price level.
  • Studying aggregate supply helps to understand economic growth factors, employment levels and the impact of inflation on the economy.

Limitations

  • It assumes all factors except price are constant which is an oversimplification.
  • It doesn’t consider the impact of international factors.
  • It assumes that the economy is either in the short run or in the long run, ignoring the transition period.