Economics
Aggregate Supply
Aggregate supply refers to the total amount of goods and services that producers are willing and able to supply at a given price level in an economy. It is represented by the aggregate supply curve, which shows the relationship between the price level and the quantity of output supplied. Changes in aggregate supply can impact the overall level of economic activity and inflation.
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eBook - ePub- W. Charles Sawyer, Richard L. Sprinkle(Authors)
- 2020(Publication Date)
- Routledge(Publisher)
Figure 16.3 .FIGURE 16.3The Aggregate Supply curveNotice that the Aggregate Supply curve slopes upward and to the right, indicating that as the price level rises, the quantity of goods and services produced by the economy increases. If this supply curve represented the supply of a particular good, the relationship between the price of the product and the quantity produced would be clear. At higher prices, producers would be willing to supply more goods and services. However, Aggregate Supply represents the economy’s total production (supply) in the short run. In this case, a higher price level is necessary to induce a higher level of total production in the economy. In the case of the Aggregate Supply of a country, we assume that in the short run the economy’s labor force, capital stock, stock of natural resources, and level of technology are all held constant. The upward slope of the Aggregate Supply curve is related both to a rising demand for the output of the economy and rising unit costs as the economy starts operating closer to full employment. Unit costs tend to rise because as output expands, the prices of some inputs used in the production of final goods will begin to rise even before the economy as a whole reaches full employment. This occurs as a result of different demand and supply conditions in the various input markets. Because the price level is a weighted average of different prices in the entire economy, if some prices are rising while the rest of the prices are constant, the price level on average may start rising even before the economy as a whole reaches full employment. One of the most important prices in the economy is the price of labor, or wages. As the economy expands output, hiring more labor causes the K/L ratio to fall in the short run. This results in a lower marginal output per unit of labor and in rising unit labor costs. This effect would contribute to rising production costs as output increases. The effect contributes to the positive slope of the Aggregate Supply curve. Thus, as the price level increases from P0 to P1 in Figure 16.3 , everything else being constant, the aggregate quantity supplied (output of goods and services) increases from Y0 to Y1
eBook - ePubContemporary Economics
An Applications Approach
- Robert Carbaugh(Author)
- 2016(Publication Date)
- Routledge(Publisher)
- The model of aggregate demand and Aggregate Supply can be used to show how output and prices are determined in the short run. An economy is in equilibrium when aggregate demand equals Aggregate Supply.
- The aggregate demand curve shows the total amount of real output that buyers will purchase at alternative price levels during a given year. Movements along an aggregate demand curve are caused by changes in the price level of the economy. Shifts in the aggregate demand curve are caused by changes in non-price factors that affect household consumption expenditures, business investment, government expenditures, and net exports of goods and services.
- According to the multiplier effect, a change in any one of the components of aggregate demand (consumption, investment, government spending, or net exports) will have a magnified impact on national output and income. The size of the multiplier depends on the spending and saving habits of consumers and businesses.
- The Aggregate Supply curve shows the relationship between the level of prices and amount of real output that will be produced by the economy in a given year. The Aggregate Supply curve is horizontal when the economy is in deep recession or depression, upward-sloping when the economy approaches full employment, and vertical when the economy achieves full employment. Changes in factors such as resource prices, resource availability, and the level of technology will cause the Aggregate Supply curve to shift.
- The model of aggregate demand and Aggregate Supply can be applied to the problems of recession and inflation. According to this model, decreases in aggregate demand or Aggregate Supply can push the economy into recession; inflation may be the result of increases in aggregate demand or decreases in Aggregate Supply. An economy experiences “stagflation” when there is both recession and inflation.
eBook - ePubFoundations of Macroeconomics
Its Theory and Policy
- Frederick S. Brooman(Author)
- 2017(Publication Date)
- Routledge(Publisher)
CHAPTER 3Aggregate Demand, Output, and Equilibrium1. Aggregate Demand and Supply
In Chapter 1 , the equilibrium of the economy was roughly described in terms of aggregate demand and supply. It was said that when the amount of money everyone wishes to spend is equal to the value of the goods and services currently being made available for purchase, the economy is in equilibrium in the sense that the situation will not itself cause changes in the general level of prices, in the level of output, or in anything else. But the concept of equilibrium implies the possibility of disequilibrium: aggregate demand may be equal to Aggregate Supply, but it may also be larger or smaller at any particular time. In this, there is a marked contrast with the relationship between National Expenditure and National Product, since these are identical in amount at all times and under all circumstances; they can never be said to be in equilibrium, because they can never differ. Nonetheless, the concepts defined in the previous chapter can be used to throw light on the conditions of equilibrium between aggregate demand and supply.For the time being, the notion of Aggregate Supply will be likened to that of National Product. This does not mean that the two are to be regarded as identical; National Product is simply a numerical measure of the flow of output, whereas the concept of supply involves the idea of volition – it is the quantity that sellers wish to sell, rather than the amount that they merely happen to have available from current production. Firms will be content to produce a given level of output only if they believe that they could not improve their profits by either increasing or reducing it It will be shown in a later chapter 1
eBook - ePub- Harlan M. Smith(Author)
- 2016(Publication Date)
- Routledge(Publisher)
The analysis is not realistic in some other respects because rising or falling price levels are not independent variables but are usually the result of changes in the expected profitability of new real investments which drive the business cycle up and down. Prices and interest rates fall when the prospects for profitable investment have worsened so much that even with lower interest rates, real investment decreases. That characterizes much of the downswing of the business cycle. The investment curve moves to the left so much as to offset the interest-rate decline’s impact on investment. Similarly, cyclical price-level increases raise interest rates, but these occur when increases in prospective investment profitability move the investment curve so much to the right as to more than offset the negative interest-rate effect on investment, so that real investment also increases. All this complicates the story of how quantities demanded or supplied and price-level changes are related. Over the business cycle, price level and output changes go up and down together.The long and short of all this is that the standard-appearing aggregate demand-and-supply curves are easily manipulated in the usual fashion, but they do not have a satisfactory theoretical basis. As interpreted by students or as explained by the textbook, they should be thrown out. The curves are not independent. The textbooks latched on too quickly to reasoning that enabled them to draw normal-looking demand-and-supply curves, but a little further analysis would have made both those aggregate curves questionable.The price level is not the independent variable to which the aggregate quantities demanded and supplied can be supposed to respond independently. Indeed aggregate quantity demanded and aggregate quantity supplied simply cannot be treated as independent of each other, for each is the major determinant of the other. According to Say’s Law, supply creates its own demand, speaking in macroe-conomic terms. This eliminated any degree of independence of the two, and it dealt with both supply and demand in the aggregate as quantities, not somehow independent schedules with price the independent variable for each.Say’s Law made so much sense that it took a long time for the error in it to be argued successfully by Keynes. But the error was that there could be a slippage at times between total production and total demand for it. There are leakages from and injections into the income stream that can result in short-run discrepancies between the total quantity of income produced and the quantity spent on that which was produced. So the bathtub theorem, dealing with imbalances between leakages and injections into the income stream, replaces Say’s Law. The bathtub theorem says that the level of income remains constant when leakages from income and injections into income are equal; when leakages exceed injections, the income level is lowered; when injections exceed leakages, the income level rises. The analogy with a bathtub drain, spigot, and water level is obvious.
eBook - ePubMacroeconomic Theory: A Short Course
A Short Course
- Thomas R. Michl(Author)
- 2015(Publication Date)
- Routledge(Publisher)
holding all other prices constant, stimulates consumers to seek substitutes for the typical good. When we aggregate over all the goods, we are considering a simultaneous increase in all the prices, so that all the relative prices remain constant. That is why an aggregate demand curve cannot be formed by simply adding up all the individual demand curves. We will see that nonetheless, macroeconomic theory does suggest reasons of a purely macroeconomic nature for the existence of an aggregate demand curve, but the aggregate demand curve can be vertical or even positively sloped, even when individual demand curves have their usual negatively sloped shape. This illustrates why macroeconomics is more than an extension of microeconomics: the whole is often different from the sum of its parts.Aggregating the pricing equation over all the firms results in an aggregate pricing equationP =(W1 + μ)which, once again, tells us that as long as the wage is fixed, firms will charge the same price no matter how much demand they experience for their products. Again, it is conventional to call the horizontal line at the price given by this equation the Aggregate Supply curve, although it would be more accurate to call it the aggregate price curve. When we drop the assumption that wages are constant in later chapters, we will find that the Aggregate Supply curve may slope upward.Just as we can find the profit share at the firm level from the mark-up, so too can we find the aggregate profit share, Π/Y, which will be equal to μ/(1 + μ)Aggregating the production function over all the firms results in an aggregate production function4 .4 The constant y− 1, which is left implicit, has the dimension constant dollars per worker per year to ensure that the production function is dimensionally consistent.Y = NObviously, if firms choose to expand output, they must hire more units of labor. In practice, this can be accomplished through longer hours per worker, or through hiring. We simplify by assuming that hours per worker are constant, so that changes in labor input are equivalent to changes in the number of employed workers.
