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Aggregate Supply: Understanding Economic Dynamics
Dive into the world of aggregate supply and its crucial role in macroeconomics. Explore short-run and long-run perspectives to gain insights into economic fluctuations, growth, and policy impacts.

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Now Playing:Aggregate supply – Example 0a
Intros
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  1. Aggregate Supply Definitions
    • Quantity of real GDP supplied
    • 3 States of Labor Markets
    • Short-run Aggregate supply
    • Long-run Aggregate Supply
  2. Short-Run Aggregate Supply
    • Keeping 3 Factors Constant
    • Potential GDP
    • Money Wage Rate
    • Upward Sloping Line
Aggregate supply
Jump to:NotesConceptFAQsPrerequisites
Notes
In this section, we are going to look at the relationship between real GDP and the price level using the aggregate supply-aggregate demand model.

Aggregate Supply Definitions

Quantity of Real GDP Supplied: The total quantity of goods and services that firms want to produce in a specified time, valued in dollars (2005).

This quantity depends on the quantity of labors employed, human and physical capital, and their technological level. Human and physical capital, and technological level can be fixed in a specified time, but the quantity of labor can vary.

The labor market can be of three states:
  1. Full Employment
  2. Above Full Employment
  3. Below Full Employment

At full employment, quantity of real GDP supplied equals potential GDP.

Aggregate Supply: the relationship between quantity of real GDP supplied and the price level.

The relationship between these two are different in two time frames: short-run and long-run. Therefore, we have two different types of aggregate supplies:
  1. Short-run aggregate supply
  2. Long-run aggregate supply


Short-Run Aggregate Supply

Short-Run Aggregate Supply: the relationship between quantity of real GDP supplied and the price level when the three following things are constant.
  1. Potential GDP
  2. Prices of other resources
  3. Money Wage Rate

The following graph shows the Short-Run Aggregate Supply

Aggregate Supply


In the graph, we see that
  1. Price level  ↑ \, \uparrow \, →  \, real GDP supplied  ↑\, \uparrow
  2. Price level  ↓ \, \downarrow \, →  \, real GDP supplied  ↓\, \downarrow
  3. Upward sloping line (positive slope)

Why is the curve upward sloping? Well the more production there is, then the higher the marginal cost.


Long-Run Aggregate Supply

Long-Run Aggregate Supply: the relationship between quantity of real GDP supplied and price level when the money wage rate changes with price level to sustain full employment.

The following graph shows the Long-Run Aggregate Supply

Aggregate Supply


In the graph, we see that
  1. Vertical Line (slope is undefined)
  2. Real GDP Supplied = Potential GDP
  3. Price level & Money Wage Rate  ↑\, \uparrow by same percentage


Shifts & Changes in Aggregate Supply

There are 2 influences that causes aggregate supply to shift:
  1. Potential GDP
  2. Money Wage Rate

Potential GDP: when potential GDP increases, it also increases long-run aggregate supply and short-run aggregate supply. They increase/shift by the same amount if we assume that full-employment price level remains constant.

Aggregate Supply


There are three ways that potential GDP can increase.
  1. Advance in technology: technological advances decrease the cost of production, so they can produce more even if they have a fixed capital and labor. Thus, this increase potential GDP.

  2. Increase in full-employment quantity of labor: The bigger the quantity of labor, the bigger real GDP is. In addition, potential GDP increases because of the labor force is getting bigger.

    Note: If capital and technology is constant, potential GDP only increases if full-employment quantity of labor increases.

  3. Increase in quantity of capital: the bigger the quantity of capital, the more productive the labor force becomes. This creates more production, thus increasing potential GDP.

    Note: Capital also includes human capital. People with more experience in producing the good will produce more of them than a person who has no experience.


Money Wage Rate: A rise in the money wage rate changes the short-run aggregate supply but does not change the long-run aggregate supply.

Aggregate Supply


In the graph, we see that
  1. Short-run aggregate supply shifts to the left: This is due to the increase in costs for the firm. It costs more to produce a good.

  2. Long-run aggregate supply does not change: A change in money wage rate causes an equal percentage change in price level. The firm has no incentive to change production, so real GDP stays as potential GDP.
Concept

Introduction to Aggregate Supply

Aggregate supply is a fundamental concept in macroeconomics that plays a crucial role in understanding economic fluctuations and growth. Our introduction video provides a comprehensive overview of this essential topic, serving as a valuable starting point for both students and professionals. By watching this video, you'll gain insights into the factors that influence the overall supply of goods and services in an economy. This article delves deeper into the intricacies of aggregate supply, exploring both short-run and long-run perspectives. The short-run aggregate supply focuses on the immediate relationship between price levels and output, while the long-run aggregate supply examines the economy's productive capacity over time. Understanding these distinctions is vital for grasping how economic policies and external shocks can impact an economy's performance. As we progress through this article, you'll develop a solid foundation in aggregate supply theory, enabling you to analyze real-world economic scenarios with greater confidence.

FAQs

  1. What is the difference between short-run and long-run aggregate supply?

    Short-run aggregate supply (SRAS) is upward-sloping and shows how output responds to price level changes in the short term. It's affected by factors like input costs and production capacity. Long-run aggregate supply (LRAS) is vertical, representing the economy's full employment output level, independent of price changes. LRAS is determined by factors such as technology, labor force, and capital stock.

  2. How do technological advancements affect aggregate supply?

    Technological advancements typically shift the aggregate supply curve to the right. They increase productivity and efficiency, allowing firms to produce more output with the same inputs. This leads to higher potential GDP and economic growth. In the short run, it can lower production costs, while in the long run, it expands the economy's overall productive capacity.

  3. What causes shifts in the aggregate supply curve?

    Shifts in the aggregate supply curve can be caused by various factors, including changes in input prices, technological progress, changes in the labor force (quantity or quality), capital accumulation, changes in government policies or regulations, and alterations in resource availability. These factors can either increase or decrease the economy's productive capacity.

  4. How does aggregate supply behave during different phases of the business cycle?

    During expansion, the short-run aggregate supply curve slopes upward, allowing for increased output as prices rise. In recession, it becomes flatter, reflecting the economy's ability to increase output without significant price increases. At full employment, the long-run aggregate supply curve is vertical, indicating the economy is producing at its maximum sustainable level.

  5. Why is understanding aggregate supply important for policymakers?

    Understanding aggregate supply is crucial for policymakers as it helps them design effective economic policies. It allows them to assess the economy's productive capacity, identify potential bottlenecks or inefficiencies, and predict how various shocks or policy changes might affect output and prices. This knowledge is essential for managing inflation, promoting sustainable growth, and addressing economic challenges.

Prerequisites

Understanding aggregate supply in economics requires a solid foundation in several key concepts. One of the most crucial prerequisite topics is changes in price and quantity. This fundamental concept plays a pivotal role in grasping the intricacies of aggregate supply and its impact on the overall economy.

Aggregate supply, which represents the total quantity of goods and services produced in an economy at various price levels, is deeply intertwined with the principles of price and quantity changes. To fully comprehend how aggregate supply functions, students must first master the dynamics of how prices and quantities interact in individual markets.

The relationship between price level changes and aggregate supply is particularly significant. As the general price level in an economy fluctuates, it directly influences the decisions of producers and the overall supply of goods and services. This connection highlights why a solid understanding of price level changes is essential for grasping the concept of aggregate supply.

When studying aggregate supply, students will encounter various factors that can shift the aggregate supply curve. Many of these factors are rooted in the basic principles of price and quantity relationships. For instance, changes in input prices, which are a key component of the changes in price and quantity topic, directly impact the cost of production and, consequently, the aggregate supply.

Moreover, understanding how firms respond to price changes in their individual markets provides valuable insights into the behavior of the aggregate supply curve. The concepts learned in the prerequisite topic of price and quantity changes, such as supply elasticity and the law of supply, are directly applicable to the analysis of aggregate supply on a macroeconomic scale.

Students who have a strong grasp of changes in price and quantity will find it easier to navigate the complexities of aggregate supply. They will be better equipped to analyze how various economic factors, such as technological advancements, changes in resource availability, or government policies, affect the overall supply in an economy.

In conclusion, the prerequisite topic of changes in price and quantity serves as a crucial building block for understanding aggregate supply. By mastering this fundamental concept, students lay the groundwork for a deeper comprehension of macroeconomic principles and their real-world applications. As they progress in their economic studies, the connections between these basic concepts and more advanced topics like aggregate supply will become increasingly apparent, enhancing their overall understanding of economic systems and dynamics.