Aggregate Supply

 
 

What is Aggregate Supply?

Aggregate Supply, or AS, forms a key concept in Macroeconomics. It represents the total supply of goods and services that firms are willing to sell at different economic price levels. Just as individual firms have their supply curves illustrating the relationship between quantity supplied and price, the whole economy has an aggregate supply curve. This aggregate supply curve is the sum of all the individual firms' supply curves in the economy and can be understood in two distinct time frames: Short Run Aggregate Supply (SRAS) and Long Run Aggregate Supply (LRAS).

Short-Run Aggregate Supply

In the short run, certain economic variables are held constant. For instance, we assume that capital (machinery, buildings) and the state of technology remain fixed. The aggregate supply is graphed as an upward-sloping curve, with the x-axis representing the overall price level and the y-axis indicating real output. This upward slope indicates that, in the short run, firms are willing to produce more when the price level rises - given that they can do so. Higher prices can increase revenues and profits, incentivising firms to maximise output.

Factors that Shift SRAS

Several factors can influence the position and shape of the SRAS curve:

  • Changes in Oil Prices: As oil is a critical input for many industries, changes in oil prices significantly impact production costs. An increase in oil prices can cause the SRAS curve to shift leftwards, indicating that firms produce less at every price level due to higher costs. Conversely, decreasing oil prices reduces production costs, causing the SRAS curve to shift rightwards.

  • Changes in Raw Material Prices: Similar to oil prices, fluctuations in the costs of raw materials impact production costs and hence the quantity of goods firms are willing to supply. For example, a spike in steel prices would increase costs for car manufacturers, shifting the SRAS curve to the left.

  • Changes in Wages: If wages rise without a corresponding increase in worker productivity, this implies higher costs for firms and results in a leftward shift of the SRAS curve. On the other hand, if wages fall or productivity rises faster than wages, this reduces costs and shifts the SRAS curve to the right.

In other words, when we have changes in the prices of factor inputs with no bearing on the productivity or productive capacity in the economy, we expect a shift in the SRAS.

Long Run Aggregate Supply

The Long Run Aggregate Supply (LRAS) presents a different perspective. Here, all economic variables can change. The LRAS is depicted as a vertical line, indicating that, in the long run, the economy's total output is unaffected by changes in the price level. The vertical nature of the LRAS curve stems from the assumption that the economy is operating at its full potential, utilising all available resources efficiently.

Factors that Shift LRAS

Changes to the LRAS occur due to factors that impact the economy's productive capacity:

  • Technological Advancements: Technology enhances productivity, allowing firms to produce more with the same resources. Therefore, technological advances can shift the LRAS curve to the right, symbolising an increase in the economy's potential output.

  • Changes in Productivity: Increasing education or skills training improves worker productivity, which can increase the economy's productive capacity. This factor would shift the LRAS curve to the right.

  • Availability of Factor Inputs: Increases in the availability of resources used in production can also increase the economy's productive capacity. For instance, the discovery of new oil reserves would lead to an increase in the LRAS, indicating a potential increase in output.


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