Aggregate Supply

10 Key excerpts on "Aggregate Supply"

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  eBook - ePub

  Economics

  The Definitive Encyclopedia from Theory to Practice [4 volumes]

  • David A. Dieterle(Author)
  • 2017(Publication Date)
  • Greenwood

    (Publisher)

  A AGGREGATE DEMAND AND Aggregate Supply

  Aggregate demand and Aggregate Supply are two of the primary concepts in macroeconomics. Aggregate means total, and demand is the desire and ability to purchase goods and services. Supply refers to the desire and ability of producers to provide goods and services. Aggregate demand is the total amount of goods and services demanded in an economy during a given time period, while Aggregate Supply is the total amount of goods and services provided. Aggregate demand is composed of all consumer spending, investment spending, government spending, and net exports (exports–imports)—the components of gross domestic product (GDP). Aggregate Supply is composed of all income, in the forms of wages, rents, profits, and interest earned.

  The British economist John Maynard Keynes (1883–1946) is credited with creating the concepts of aggregate demand and Aggregate Supply. He used these concepts in the 1930s to explain how governments can recover from recessions by increasing government spending to impact aggregate demand, which in turn would increase Aggregate Supply. Keynes did the lion’s share of his writing and economic thought from 1920 to 1940. Prior to Keynes, market explanations centered on classical economics, popularized by the writings of Adam Smith (1723–1790). Smith emphasized the market concept of laissez faire, which is the minimal use of government actions to control economic activity.

  Aggregate demand and Aggregate Supply are graphed on the aggregate demand and Aggregate Supply graph with the y-axis being the general price level, or CPI, and the x-axis being real GDP. The aggregate demand curve is downward-sloping to the right while the Aggregate Supply curve is upward-sloping.

  Aggregate Demand

  Most economists support the downward-sloping aggregate demand (AD) curve for three primary reasons: the wealth effect, the interest rate effect, and the exchange rate effect. All three of the explanations for the downward-sloping AD curve center around lower prices, which induce greater quantity demanded and the downward slope of the AD curve. When the price level falls, wages do not change immediately, which makes consumers feel wealthier so they purchase more goods and services than before. When interest rates fall, consumer spending on durable goods such as homes and cars and business investments on capital goods will increase. When the domestic exchange rate falls, domestic exports become relatively cheaper to foreign consumers and foreign sales will increase.

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  Chinese Economists on Economic Reform - Collected Works of Lou Jiwei

  • Lou Jiwei, China Development Research Foundation(Authors)
  • 2013(Publication Date)
  • Taylor & Francis

    (Publisher)

  Equilibrium in Aggregate Supply and demand, and equilibrium in ‘the use of national income’ and the ‘production of national income,’ are two pairs of economic concepts that are used to analyze short-term economic phenomena. Using them as analytical tools can help us touch upon certain structural issues in our national economy and its prospects for long-term steady growth. They cannot be used to explain these issues in a fully comprehensive way. Nonetheless, equilibrium in our aggregate economy is the basis for any structural evolution and long-term steady growth. One could even say that correcting short-term imbalances in the overall economy is a prerequisite for steady economic growth. Therefore, it is absolutely necessary to have a deep understanding of the full meaning of these two pairs of concepts, as well as how they differ in terms of the policy considerations each one implies.

  Articles on economic topics in our country often equate the ‘aggregate demand and Aggregate Supply equilibrium’ with ‘equilibrium in use of our national income and the production of our national income.’ They refer to an ‘excess of aggregate demand over Aggregate Supply’ as though it were the same as the ‘excess distribution of the national income.’ In fact, these two pairs of concepts are linked but also have certain distinctions. The implications of their corresponding parts are not equivalent. Let’s look at a comparative analysis.

  1. The Aggregate Supply and the amount of ‘national income production’

  Simply put, ‘Aggregate Supply’ refers to those products and services that have an ‘actual practical-use value’ that can be produced by existing production capacities within one year. It can be roughly expressed in terms of the expected gross national product (GNP) as measured in constant prices, or by the expected national income. The thing that Aggregate Supply focuses on is the production capacity of such productive factors as assets, labor, land, imported materials, and foreign capital inflows. Within any given year, these are limited. Each is constrained by the quantity and quality of all other factors. For example, a quantitative maximum is imposed on imported materials and the amount of our foreign debt by the smallest extent of foreign exchange reserves and the highest amount of debt-servicing. ‘Aggregate Supply’ refers to the maximum amount of ‘well-being’ that can be produced by the full capacity of production factors, after they are combined in optimal fashion. It is also referred to as the ‘production-possibility frontier’ or the ‘potential production level.’ We should say that referring to the maximum well-being of people is more accurate, since it excludes from the figures production of overstocked things that people don’t need, either for immediate or long-term consumption (as investment).

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  Applied Intermediate Macroeconomics

  • Kevin D. Hoover(Author)
  • 2011(Publication Date)
  • Cambridge University Press

    (Publisher)

  But Aggregate Supply and aggregate demand are differ-ent things, and ex ante they need not be equal. Aggregate demand is gov-erned by the choices of spenders, given their incomes. Aggregate Supply is governed by the choices of firms, given the available productive resources. In the end, it is these productive resources that set the upper limit to GDP. 309 310 Aggregate Production Aggregate demand may fall short, and GDP may turn out to be less than it could be. But no matter how much aggregate demand rises, GDP cannot exceed the ability of the workers in factories, offices, and other worksites to produce. In this and the following three chapters we examine Aggregate Supply. We know from our discussion of the circular flow of income and produc-tion (Chapter 2, section 2.2) that the firm sector purchases factors of produc-tion and transforms them into final goods and services. This is the heart of Aggregate Supply. The decisions that govern the production process are not made by the firm sector as a whole. Rather they are made by each individ-ual firm. As a result, even though we are, in the end, concerned primarily with the aggregate product (GDP), looking at the production problem from the point of view of the firm is a valuable prelude to the main business of the chapter. It will help us to build up our intuitions and to cement essential terminology in our minds. 9.1 The Production Decisions of Firms 9.1.1 Production Possibilities Technology Consider a particular product, say, a barrel of gasoline. An oil refinery uses raw petroleum, energy, various chemicals, and various types of labor, among other INPUTS , to produce its OUTPUT – gasoline. The design of the refinery and its work practices embody a particular TECHNIQUE for producing gaso-line. A technique is like a recipe for a cake. The inputs are the list of the ingredients used, the output (or possibly outputs) is the cake, and the recipe is the set of instructions for making the cake.

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  eBook - ePub

  Economics for Investment Decision Makers

  Micro, Macro, and International Economics

  • Christopher D. Piros, Jerald E. Pinto(Authors)
  • 2013(Publication Date)
  • Wiley

    (Publisher)

  In other words, wages and prices that are inflexible or slow to adjust in the short run adjust to changes in the price level over the long run. Thus, over the long run, when the aggregate price level changes, wages and other input prices change proportionately so that the higher aggregate price level has no impact on Aggregate Supply. This is illustrated by the vertical long-run Aggregate Supply (LRAS) curve in Exhibit 5-14. As prices move from P 1 to P 2, the quantity of output supplied remains at Q 1 in the long run. The only change that occurs is that prices shift to a higher level (from P 1 to P 2). The position of the LRAS curve is determined by the potential output of the economy. The amount of output produced depends on the fixed amount of capital and labor and the available technology. This classical model of Aggregate Supply can be expressed as: where is the fixed amount of capital and is the available labor supply. The stock of capital is assumed to incorporate the existing technological base. 8 The available labor supply is also held constant, and workers are assumed to have a given set of skills. The long-run equilibrium level of output, Y 1 in Exhibit 5-14, is referred to as the full employment, or natural, level of output. At this level of output, the economy’s resources are deemed to be fully employed and (labor) unemployment is at its natural rate. This concept of a natural rate of unemployment assumes the macroeconomy is currently operating at an efficient and unconstrained level of production. Companies have enough spare capacity to avoid bottlenecks, and there is a modest, stable pool of unemployed workers (job seekers equal job vacancies) looking for and transitioning into new jobs. 3.3. Shifts in Aggregate Demand and Supply In the next two sections, the aggregate demand (AD) and Aggregate Supply (AS) models are used to address three critical macroeconomic questions: 1. What causes an economy to expand or contract? 2

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  eBook - PDF

  Macroeconomics

  A Contemporary Introduction

  • William A. McEachern(Author)
  • 2016(Publication Date)
  • Cengage Learning EMEA

    (Publisher)

  Unexpected changes in the price level can move output in the short run away from its potential level. But if firms and resource suppliers fully adjust to price surprises, the economy in the long run moves toward its potential output. Potential output is the anchor for analyzing Aggregate Supply in the short run and long run. Copyright 2017 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. Chapter 10 Aggregate Supply 231 Summary 1. Short-run Aggregate Supply is based on resource demand and supply decisions that reflect the expected price level. If the price level turns out as expected, the economy produces its potential output. If the price level exceeds expectations, short-run output exceeds the economy’s potential, creating an expansionary gap. If the price level is below expectations, short-run output falls short of the economy’s potential, creating a recessionary gap. 2. Output can exceed the economy’s potential in the short run, but not in the long run. In the long run, higher nominal wages will be negotiated at the earliest opportunity. This increases the cost of production, shifting the short-run Aggregate Supply curve leftward along the aggregate demand curve until the economy produces its potential output. 3. If output in the short run is less than the economy’s potential, and if wages and prices are flexible enough, lower nominal wages will reduce production costs in the long run. These low- er costs shift the short-run Aggregate Supply curve rightward along the aggregate demand curve until the economy produces its potential output.

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  eBook - PDF

  Economics

  A Contemporary Introduction

  • William A. McEachern(Author)
  • 2016(Publication Date)
  • Cengage Learning EMEA

    (Publisher)

  Unexpected changes in the price level can move output in the short run away from its potential level. But if firms and resource suppliers fully adjust to price surprises, the economy in the long run moves toward its potential output. Potential output is the anchor for analyzing Aggregate Supply in the short run and long run. Copyright 2017 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. Chapter 24 Aggregate Supply 563 Summary 1. Short-run Aggregate Supply is based on resource demand and supply decisions that reflect the expected price level. If the price level turns out as expected, the economy produces its potential output. If the price level exceeds expectations, short-run output exceeds the economy’s potential, creating an expansionary gap. If the price level is below expectations, short-run output falls short of the economy’s potential, creating a recessionary gap. 2. Output can exceed the economy’s potential in the short run, but not in the long run. In the long run, higher nominal wages will be negotiated at the earliest opportunity. This increases the cost of production, shifting the short-run Aggregate Supply curve leftward along the aggregate demand curve until the economy produces its potential output. 3. If output in the short run is less than the economy’s potential, and if wages and prices are flexible enough, lower nominal wages will reduce production costs in the long run. These low- er costs shift the short-run Aggregate Supply curve rightward along the aggregate demand curve until the economy produces its potential output.

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  Macroeconomics

  Principles and Policy

  • William Baumol, Alan Blinder(Authors)
  • 2015(Publication Date)
  • Cengage Learning EMEA

    (Publisher)

  Ava i lable Suppl i es of Labor and Cap i ta l The last determinants o f the p osition o f the a gg re g ate suppl y curve are the ones we studied in Chapter 7 : The bi gg er the Real GDP ( Y ) 5,500 Price Level ( P ) 6,000 100 S 0 (lower wages) S 1 (higher wages) S 1 S 0 B A Figure 2 A Shift of the Aggregate Supply Curve NOTE: Amounts are in billions of dollars per year. Productivity is the amount of output produced by a unit of input. Copyright 2016 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. Chapter 10 Bringing in the Supply Side: Unemployment and Inflation? 197 econom y —as measured b y its available supplies of labor and capital—the more it is capable o f producin g . Thus : As the labor f orce grows or improves in qualit y , and as investment increases the capital stock, the aggregate suppl y curve shifts outward to the right, meaning that more output can be pro d uce d at any given price l eve l . So, f or example, the g reat investment boom o f the late 1990s, b y boostin g the suppl y o f capital, le f t the U.S. econom y with a g reater capacit y to produce g oods and services—that is, it shifted the a gg re g ate suppl y curve outward. The investment slump of the late 2000s d i d precise ly t h e reverse . These factors, then, are the ma j or “other thin g s” that we hold constant when drawin g an Aggregate Supply curve: nominal wage rates, prices of other inputs (such as energy), technolo gy , labor f orce, and capital stock.

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  eBook - ePub

  Foundations of Macroeconomics

  Its Theory and Policy

  • Frederick S. Brooman(Author)
  • 2017(Publication Date)
  • Routledge

    (Publisher)

  CHAPTER 10Prices, Wages, and Aggregate Supply

       

  1. The Aggregate Supply Curve

  In the last five chapters, the various components of aggregate demand – consumption, investment, government spending, exports, and (negatively) imports – have been examined in detail, especially with regard to their relationship with current real income. It was found that consumption depends partly on income and partly on such other factors as consumers’ assets and liabilities; that investment may be influenced to a small extent by current income but depends much more on firms’ expectations of future profit, on past changes in income, and on the cost of financing new projects; that government spending, being largely determined by political decisions about such matters as the necessary scale of defense expenditure, is essentially autonomous of current income; and that, while imports can be expected to vary with income to some degree, exports are affected only indirectly through the feedback described in Chapter 8 . In the light of all these findings, the original “equilibrium equation”

  C + I + G + E – M

  has been amplified and extended in various ways so as to bring in the marginal propensities to consume, import, and invest; to allow for the effects of taxation; to introduce additional variables such as income from previous periods, and so on.

  Obviously the equation could be expanded and elaborated still further along these lines. However, the fact remains that, as it stands, the “equilibrium condition” is subject to a serious limitation – namely, that because all quantities are stated in real terms, it throws no light on the determination of the general price level. Yet the behavior of prices is of great interest and importance to individuals, business firms, and governments. Large and sudden changes can be highly disruptive – impoverishing or enriching people according to whether they happen to be debtors or creditors, upsetting normal economic calculations, and creating uncertainties that inhibit the rational use of resources. Even where governments aim at minimum interference with the working of the economy, they usually attempt to maintain reasonable price stability through monetary policy. No theory of the working of the economy as a whole can be complete, therefore, unless it explains the determination of the general price level as well as the volume of “real” output. A full explanation will not be possible until money

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  A Primer on Macroeconomics

  Policies and Perspectives

  • Thomas M. Beveridge(Author)
  • 2018(Publication Date)
  • Business Expert Press

    (Publisher)

  Say’s Law of Markets . Note the preeminence of the supply side! French economist Jean-Baptiste Say argued that the act of producing goods and services generates enough income for households (within which the productive resources reside) to be able to purchase all of that output. In other words, the production process creates exactly the spending power needed to buy the nation’s output. If, for some reason, this is not so, then prices will adjust. If there is an overabundance of goods (a very good harvest), then prices will decrease to ensure that all goods are bought. According to Say’s Law, Aggregate Supply and aggregate demand will be equal and, given full employment in the labor market, that equality will be at the full-employment output level.

  THINK IT THROUGH : “But what if, instead of spending their income, households choose to save some of their money?” Again, the Classical perspective is long run—short-run fluctuations in consumption and saving are irrelevant. In addition, if saving flows into the loanable funds market , then it will be channeled to borrowers who will spend with no loss of overall spending power. We consider the loanable funds market later in this section.

  The Economy Is Self-Correcting

  This is directly contradictory to Keynes’ view that the economy could become stuck in a situation like the Great Depression. Today, this previously discredited view can be found repeated in introductory texts—the economy does have a self-correcting mechanism that eliminates cyclical unemployment through the application of market forces. As referred to earlier, the remaining bone of contention is how rapidly the process operates.

  “Money Is a Veil”

  In Chapter 4 (Volume I), we discussed the Quantity Theory of Money (M × V = P × y), which states that the money supply (M) will circulate at a velocity (V) sufficient to purchase the value of nominal GDP (P × y). Changes in the money supply will have no impact on real wages, real GDP, the level of employment, or any other real variable in the economy and, in that sense, money is said to be neutral

  . However, “money matters” with respect to inflation because, if the money supply were to be doubled then, after the dust had settled (in the long run!) there would be a doubling in the aggregate price level. For the Classical economists, a tight grip on the government’s ability to print money is the key to controlling inflation.

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  Macroeconomics

  Principles & Policy

  • William Baumol, Alan Blinder, John Solow, , William Baumol, Alan Blinder, John Solow(Authors)
  • 2019(Publication Date)
  • Cengage Learning EMEA

    (Publisher)

  130 Part 2 The Macroeconomy: Aggregate Supply and Demand Y c Output Y b Y a 0 L 1 a b Hours of Labor Input c K 1 K 2 K 3 Figure 1 Production Functions Corresponding to Three Different Capital Stocks held constant in this graph.) The middle curve 0K 2 is the production function corresponding to some larger capital stock K 2 , and the upper curve 0K 3 pertains to an even larger capital stock K 3 . To keep things simple at first, suppose hours of work do not grow over time, but rather remain fixed at L 1 . However, the nation’s businesses invest in new plant and equipment, so the capital stock grows from K 1 in the first year to K 2 in the second year and K 3 in the third year. Then the economy’s capacity to pro- duce will move up from point a in year 1 to point b in year 2 and point c in year 3. Potential GDP will, there- fore, rise from Y a to Y b to Y c . Because hours of work do not change in this example (by assumption), every bit of this growth comes from rising productivity, which is in turn due to the accumulation of more capital. 2 In general: For a given technology and a given labor force, labor productivity will rise as the capital stock increases. This conclusion is hardly surprising. Employees who have more capital to work with can obviously produce more goods and services. Just imagine manufacturing a desk, first with only hand tools, then with power tools, and finally with all the equipment available in a modern furniture factory. Or think about selling books from a sidewalk stand, in a book- store, or over the Internet. Your productivity would rise in each case. Furthermore, workers with more capital are almost certainly blessed with newer—and, hence, better—capital as well. This advantage, too, makes them more productive. Again, compare one of Henry Ford’s assembly-line workers of a century ago to an autoworker in a Ford plant today.

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