Aggregate Supply

Aggregate supply is a modeling tool economists use to show the relationship

between the aggregate price level and the aggregate level of output in a given
economy. Aggregate, when used in this context, means the total amount of something,
so an aggregate supply definition is: the total amount of goods and services supplied
by firms at a given price level. When using this model in a graph, it's represented by
the aggregate supply curve. An upward-sloping curve denotes the positive
relationship between the amount people are willing to spend on good and services and
the amount of goods and services firms are willing to supply.
Aggregate Supply Curve

Types of Aggregate Supply

There are two types of aggregate supply, short-run aggregate supply
(SRAS) and long-run aggregate supply (LRAS). These two types are displayed
quite differently on a graph. SRAS is upward sloping, whereas LRAS is represented
by a vertical line.
Short-run and Long-run Aggregate Supply Curves
SRAS is upward-sloping because there is a positive relationship between the price
people are willing to pay for goods and services and the supply firms are willing to
produce; also, in the short run, prices are sticky. Thus prices and wages don't change
in short-run. It takes a long time for prices to adjust, meaning prices do change in the
long run. That is why the LRAS is vertical. Once prices adjust, the economy will
return to its potential output. To put it simply the LRAS line on a graph represents the
economy's potential output, which is the expected sustainable level of GDP given a
nation's resources and technology.

Determinants of Aggregate Supply

Determinants of Aggregate supply are different factors in an economy that can
change, or shift, the aggregate supply curve.

 Factor Prices: Factor prices represent the cost of resources used to produce goods. This
includes raw materials such as lumber or steel, as well as energy or wages. This determinant
effects Aggregate because if factor prices rise, then firms will be able to supply fewer goods
at a given price, and vice versa if the fall. For example, if the price of steel rises, it would cost
more for auto manufactures to make cars. Therefore, manufactures would be able to make
fewer cars at the same aggregate price level as before the rise in factor prices.
 Technology: Technology is a determinant of aggregate supply because it impacts
productivity. If productivity rises from the introduction of new technology, then firms will be
able to produce more good at the same aggregate price level. It's hard to envision a decrease
or loss in technology which leads to lower productivity, but a software virus could disable
computers and automated production.
 Labor Productivity: An increase in labor productivity can determine a firm's level of output.
For example, if the workforce becomes better educated, allowing them to work more
efficiently, then goods can be produced at higher rate at the same given price level.
 Availability of Factors of Production: The availability of things used in producing goods and
services is another determinant of aggregate supply. If the availability of factors of
production increases, then firms can produce more goods at a given price, and vice versa. For
example, say a new disease wipes out the chicken population, if that were to happen, then a
restaurant that makes fried chicken would not be able to supply the same amount of that
good at the same given price level as before.
 Capital Productivity: Capital productivity measure how efficiently capital is being used to
produce goods and services. This is also a determinant of aggregate supply. If firms began to
mismanage their capital, causing them to use it inefficiently, then their level output or supply
would drop at the same given price.
 Government Rules, Taxes, and Subsidies: The final three determinants of aggregate supply
are all related in that they are determined by the government. If there is a change in
government rules such as new regulations on the treatment of livestock, that would lower
the output of meat factories. Conversely, if the government increased subsidies for farmers
that raised livestock, that would increase the level of output. Taxes are the final determinant
of aggregate supply. If income taxes rise, then the labor force will demand higher wages
causing a decrease in output at the same aggregate price level. Taxes can also affect firms
more directly in the form of corporate taxes. If corporate taxes are lowered, that would
increase the amount of supply firms would be able to supply at the given price level.

Shifts in Aggregate Supply

The aggregate supply curve can be shifted by the determinant previously discussed.
Its important to note the difference between a shift in the aggregate supply curve and
movement along the curve. Movement along the curve represents a rise or fall in the
aggregate price level, whereas a shift in the curve causes an increase or decrease in
the level output at any price level. If a determinant increased aggregate supply, then
the curve would shift to the right. Conversely, a decrease would cause a shift to the
left

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A rightward shift causing an Increase in aggregate supply

a leftward shift causing a decrease in aggregate supply

Aggregate Demand
Aggregate demand is a modeling tool economists use to show the relationship
between the aggregate price level and aggregate spending by all firms, households,
government agencies, and foreign nations. In essence, aggregate demand represents
the total amount people are willing to spend in an economy at a given price level.
When using this model on a graph, it represented by an aggregate demand curve that
shows the aggregate amount spent at any given price level and is downward sloping.
It is a negative relationship because as prices rise, people are less willing to spend
their money.
Aggregate Demand in AS/AD graph

Determinants of Aggregate Demand

Like aggregate supply, there are also determinants of aggregate demand that can shift
the AD curve.