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Aggregate supply refers to the "total supply of goods and services" that businesses can sell in a national economy—at a particular price for a particular period. It speaks about consumer goods that clients buy for their own use. A change in aggregate supply results from increased or decreased aggregate demand.
Since supply changes typically lag demand changes, aggregate supply typically calculated over a year. The best way to define aggregate supply is as the total amount of goods and services generated within an economy at a particular price point and time frame. It is depicted by a curve that demonstrates the connection between price levels and the volume of output that businesses are prepared to supply.
There are two main reasons why the amount of aggregate output supplied might rise as price level P rises, i.e., why the AS curve is upward sloping:
- Given some nominal variables, such as the nominal wage rate, which is presumed to be fixed in the short run, the short-term AS curve is drawn. With a lower real wage rate implied by a higher price level P, there is an incentive to generate more production.
- On the other hand, in the long term in the neoclassical model, the nominal wage rate varies with the state of the economy. (High unemployment causes nominal wages to decline, which brings about full employment.) As a result, the aggregate supply curve is vertical over the long term.
One alternative model is based on the idea that any economy uses a variety of heterogeneous types of inputs, such as labor and fixed capital equipment. Both of the two primary input kinds may be unemployed. Because (1) some nominal input prices are fixed in the short run and (2) as output rises, more and more production processes experience bottlenecks, the AS curve has an upward slope.
There are generally three alternative degrees of price-level responsiveness of aggregate supply. They are:
- Short-run aggregate supply (SRAS): In the near term, enterprises only have one fixed element of production (often capital), and some factor input prices are sticky. As can be seen from the flat section of the curve in the graph above, the amount of total production supplied is quite sensitive to the price level.
- Long-run aggregate supply (LRAS): The macroeconomic model assumes that everything in the economy is being used to its full potential at this moment, hence the only factors that have an impact on the LRAS in the long term are capital, labor, and technology.
Understanding how variations in demand, prices, costs, and productivity impact an economy's overall performance requires an understanding of aggregate supply. We can learn more about how certain events and policies may impact economic growth, inflation, unemployment, and income distribution by investigating the variables that affect aggregate supply.
