What Is Aggregate Supply?

What Is Aggregate Supply?

Let me explain aggregate supply to you directly: it's the relationship between an economy's average price per good and the quantity of goods of average value supplied. The term refers to the supply of products that companies produce and plan to sell at a certain price in a given period. Put simply, it's the finished goods that consumers purchase during a specified time. Aggregate supply is represented by the aggregate supply curve, and there's typically a positive relationship between aggregate supply and the price level.

Key Takeaways

Here's what you need to know: Aggregate supply is the total amount of goods and services produced at a specific price point for a particular period. Short-term changes in aggregate supply are impacted most significantly by increases or decreases in demand. Long-term changes in aggregate supply are impacted most significantly by new technology or other changes in an industry. Aggregate supply is the opposite of aggregate demand, which is the total demand for finished goods and services over a specified time.

Understanding Aggregate Supply

I want you to understand that aggregate supply is sometimes described as the relationship between price level and real GDP. Where aggregate supply involves all products supplied by a nation's producers, simple supply is the supply of products or services available from a single producer. Aggregate supply is commonly affected by prices. Rising prices generally indicate to businesses that they should expand production to meet a higher level of aggregate demand.

When demand increases amid constant supply, consumers compete for available goods and pay higher prices. This dynamic induces firms to increase output to sell more goods. The resulting supply increase causes prices to normalize while output remains elevated.

A shift in aggregate supply can be attributed to many variables, including changes in the amount and quality of labor, technological innovations, wage increases, an increase in production costs, changes in producer taxes and subsidies, and changes in inflation. Some of these factors lead to positive changes in aggregate supply while others cause a decline in it.

For example, increased labor efficiency, perhaps through outsourcing or automation, raises supply output by decreasing the labor cost per unit of supply. By contrast, wage increases place downward pressure on aggregate supply by increasing production costs. Remember, aggregate supply is usually calculated over a year because changes in supply tend to lag changes in demand.

Aggregate Supply Over Time

In the short run, aggregate supply responds to higher demand and higher prices by increasing the use of current inputs in the production process. The level of capital is fixed over shorter periods, meaning a company cannot do things like build a new factory or introduce a new technology to increase production efficiency. Instead, the company ramps up supply by getting more out of its existing factors of production, such as assigning workers more hours or increasing the use of existing technology.

Over the long run, aggregate supply is not affected by the price level and is driven only by improvements in productivity and efficiency. Such improvements include increases in the level of skill and education among workers, technological advancements, and increases in capital. Certain economic viewpoints, such as the Keynesian theory, assert that long-run aggregate supply is still price elastic up to a certain point. Once this point is reached, supply becomes insensitive to changes in price. The aggregate supply curve depicts aggregate supply graphically, portraying the relationship between price levels and the quantity of output that firms are willing to provide to consumers in the market.

Aggregate Supply vs. Aggregate Demand

Aggregate supply is the opposite of aggregate demand. While aggregate supply is the total amount of goods and services that producers are willing to sell at a certain price level, aggregate demand is the total amount of demand for finished goods and services in the economy over a specified time. It is expressed as a dollar value that corresponds to how much consumers spend on these products.

Aggregate demand includes a variety of products, such as consumer goods, capital goods, imports and exports, and government spending programs. You can calculate aggregate demand by adding together the total amount of consumer goods, private investment, government spending, and net exports (exports less imports). Several factors affect the aggregate demand in the economy, including interest rates, foreign exchange rates, inflation, and income levels.

Example of Aggregate Supply

Assume that XYZ Corporation produces 100,000 widgets per quarter at a total expense of $1 million. If the cost of a critical component that accounts for 10% of that expense doubles in price because of a shortage of materials or other external factors, XYZ Corporation could produce only 90,909 widgets if it still spends $1 million on production. This reduction would represent a decrease in aggregate supply. The lower amount of aggregate supply could mean that demand exceeds output, and that, coupled with the increase in production costs, is likely to lead to a rise in price.

Why Is Aggregate Supply Important?

Aggregate supply is important because it can affect output and price levels in an economy. In turn, this can impact inflation levels. In addition, changes in aggregate supply can influence the decisions that businesses make about production, hiring, and investments.

What Is Aggregate Demand?

Aggregate demand is the total demand for all finished goods and services in the market during a certain time. This figure is commonly expressed as a dollar figure—notably the prices at which consumers pay for finished products. Aggregate demand is calculated by adding together consumption spending, government spending, investment spending, and a country's net exports.

What Is the Law of Supply and Demand?

The law of supply and demand is an economic theory that describes the relationship between sellers and buyers of goods and services. According to the law of supply, supplies of goods and services are propelled by higher prices while lower prices cause supplies to drop. The law of demand, on the other hand, suggests that higher prices cause demand for goods and services to drop while lower prices lead to an increase in demand for them.

What Factors Affect Supply in the Economy?

Factors that affect supply in the economy include prices, production costs, the number of producers, production technology, and the labor market.

The Bottom Line

Aggregate supply is defined as the total amount of goods and services that producers make and are willing to sell at a certain price within a certain time. Changes in supply can affect demand and how the economy functions. Aggregate supply data helps businesses and other entities make better-informed decisions about their financial situations, budgets, and plans for the future.