AGGREGRATE

SUPPLY
PRESENTED BY:
MR. IMPERIAL
AGGREGATE
SUPPLY
Aggregate supply is the
total amount of goods
(including services) supplied
by businesses within a country
at a given price level. The
higher the price level, the
greater the incentive of
businesses to produce more of
their goods for the market.
Aggregate supply, also
known as total output, is the
total supply of goods and
services produced within an
economy at a given overall
price in each period.
 The quantity of real GDP supplied is the total amount of
final goods and services that firms in the country plan to
produce, and it depends on the quantities of
 Labor employed
 Capital, human capital, and state of technology
 Land and natural resources
 Entrepreneurial talent
You saw in the previous unit that at full employment, real
GDP equals to potential GDP . The quantities of land,
capital, and human capital, the state of technology, and the
amount of entrepreneurial talent are fixed. Labor market
equilibrium determines the quantity of labor employed,
which is equal to the quantity of labor demanded and the
quantity of labor supplied at the equilibrium wage rage.
Over the business cycle, real GDP fluctuates around
potential GDP because the quantity of labor employed
fluctuates around its full employment level. The aggregate
supply-aggregate demand model explains these fluctuations.
 Aggregate Supply is the relationship between the quantity of
real GDP supplied and the price level when all other influences
on production plans remain the same. This relationship can be
described as follows:
Other things remaining the same, the higher the price level,
the greater is the quantity of real GDP supplied, and the lower the
price level the smaller is the quantity of real GDP supplied.
Figure 6.1 illustrates aggregate supply as an aggregate
supply schedule and aggregate supply curve. The aggregate
supply schedule lists the quantities of real GDP supplied at each
price level, and the upward-sloping AS curve graphs these points.
The figure also shows potential GDP: P16 trillion in the
figure. When the price level is 105, the quantity of real GDP
supplied is P16 trillion, which equals potential GDP (at point C
on the AS curve)
Along the aggregate supply curve, the price level is the only
influence on production plans that changes. A rise in the price
level brings an increase in the quantity of real GDP supplied and
a movement along the aggregate supply curve; a fall in the price
level brings a decrease in the quantity of real GDP supplied and a
movement down along the aggregate supply curve.
Among the other influences on
production plan that remind
constant along the AS curve are
 The money wage rate
 The money prices of other
resources.
In contrast, along the potential
GDP line, when the price level
changes, the money wage rate and
the money prices of other
resources change by the same
percentage as the change in the
price level to keep real wage rate
(and other real prices) at full-
employment equilibrium level.
 1. Resource Prices- a change in the cost or
availability of key resources will affect the amount
that producers can make in the short-run.
2. Actions by the Government- a change in
taxes, subsidies, or regulations can change the
incentives of producers and affect the amount they
SHIFTERS produce.
3. Productivity- a change in technology or human
capital can change the amount producers can make
with the same number of resources.
4. Inflation- If aggregate supply falls but
aggregate demand remains unchanged, there is
upward pressure on prices and inflation
THE PRINCIPLE OF SHORT AND LONG
RUN AGGREGATE SUPPLY
 Short run aggregate supply
A curve is an upward sloping curve that depicts the
number of goods and services produced at each price level in
the economy. Increasing the price level causes a movement
along the short run aggregate supply curve, leading to higher
output and higher employment.
 Long-run aggregate supply (LRAS)
A curve that shows the relationship between price
level and real GDP that would be supplied if all prices,
including nominal wages, were fully flexible; price can
change along the LRAS, but output cannot because that
output reflects the full employment output.
WILL THE FOLLOWING INCREASE OR
DECREASE SHORT-RUN AGGREGATE
SUPPLY? IDENTIFY THE SHIFTER.
1. An increase in nominal wages for many workers.
2. A significant increase in the amount of physical
capital.
3. Random and persistent power outages for several
months.
4. A decrease in corporate taxes on producers
5. Consumers and businesses expect higher
inflation.
WILL THE FOLLOWING INCREASE OR DECREASE SHORT-RUN
AGGREGATE SUPPLY? IDENTIFY THE SHIFTER.

1. An increase in nominal wages for many workers. Costs↑ SRAS↓

2. A significant increase in the amount of physical capital. ↑ Resources SRAS↑

3. Random and persistent power outages for several months. Resources SRAS↓

4. A decrease in corporate taxes on producers. Business Taxes↓ SRAS↑

5. Consumers and businesses expect higher inflation. Costs↑ SRAS↓

WILL THE FOLLOWING
INCREASE OR
DECREASE LONG-RUN
AGGREGATE SUPPLY?
IDENTIFY THE SHIFTER.

1. An increase in nominal
wages for many workers.
2. A significant increase
in the amount of physical
capital.
WILL THE FOLLOWING INCREASE OR
DECREASE LONG-RUN AGGREGATE
SUPPLY? IDENTIFY THE SHIFTER.

1. An increase in nominal wages for many

workers. LRAS will stay the same
2. A significant increase in the amount of
physical capital. Capital Stock↑ LRAS↑
SHIFTER OF SHORT-RUN AGGREGATE SUPPLY
 Resource Prices- a change in the cost
or availability of key resources will
affect the amount that producers can
make in the short-run.
 Actions by the Government- a change
in taxes, subsidies, or regulations can
change the incentives of producers and
affect the amount they produce.
 Productivity- a change in technology
or human capital can change the
amount producers can make with the
same number of resources.
 Capital Stock- the accumulation of physical
capital, like factories, tools, and equipment, used REMEMBER
to produced goods and services. In economics, :
"capital" is never money.
 Negative Supply Shock- an unexpected
decrease in the availability of a key resource.
This causes a decrease in the short-run aggregate
supply.
 Positive Supply Shock- an unexpected increase
in the availability of a key resource. This causes
an increase in the short-run aggregate supply.
WHY THE AS CURVE
SLOPES UPWARD?

Why does the quantity of

real GDP supplied increases when
the price level rises and decrease
when the price level falls? The
answer is that a movement along
the AS curve brings a change in
the real wage rate (and changes in
the real cost of other resources
whose money price are fixed). If
the price level rises, the real wage
rate changes, firms change the
quantity of labor employed and
the level of production.
 CONCRETE EXAMPLE
A firm sells ketchup for P45 a bottle. The real wage rate
of ketchup bottling workers is 10 bottle of ketchup. That is, the
firm must sell 10 bottles of ketchup to buy one day of labor. Now
suppose the price of ketchup fall to P37 a bottle. The real wage
rate of as bottling worker has increased to 12 bottles - the firm
must now sell 12 bottles of ketchup to buy one day of labor. If the
price of a bottle of ketchup increased, the real wage rate of a
bottling worker would fall. For example, if the price increased to
P50 a bottle. The real wage rate would be 9 bottles per worker -
the firm needs to sell 9 bottles of ketchup to buy one day of labor.
Firms respond to a change in the real wage rate by
changing the quantity of labor employed and the quantity
produced. For the economy, employment and real GDP change.
There are three ways in which these changes occur:
⚫ Firms change their output rate.
⚫ Firms shut down temporarily or restart production.
⚫ Firms go out of business or start up in business.
CHANGE IN OUTPUT RATE
To change its output rate, a firm must change the quantity of labor
that it employes. It is profitable to hire more labor if the additional labor
costs less than the revenue it generates. If the price level rises and the
money wage rate doesn't change, an extra hour of labor that was
previously unprofitable becomes profitable. So, when the price level
rises and the money wage rate doesn't change, the quantity of labor
demanded and production increase. If the price level falls and the money
wage rage doesn't change, a day of labor that was previously profitable
becomes unprofitable. So, when the price level falls and the money
wage rate doesn't change the, quantity of labor and production decrease.
 TEMPORARY SHUTDOWNS
AND RESTARTS
A firm that is incurring a loss might foresee a
profit in the future. Such a firm might decide to shut
down temporarily and lay off its workers. The price
level relative to the money wage rate influences
temporary shut down decisions. If the price level
rise relative to wages, fewer firms decide to shut
down temporarily; so, more firms operate, and the
quantity of real GDP supplied increases. If the price
level falls relative to wages, a larger number of
firms find that they cannot earn enough revenue to
pay the wage bill and so temporarily shut down.
The quantity of real GDP supplied decreases.
BUSINESS FAILURE AND STARTUP
People create businesses in the hope of earning a
profit. When profits are squeezed or when losses arise,
firmer fall, fewer newer firms start up, and the number of
firms decreases. When profits are generally high, fewer
firms fail, more firms start up, and the number of firms
increases.
The price level relative to the money wage rate
influence the number of firms in business. If the price level
rises relative to wages, profits increase, the number of firms
in business increases, and the quantity of real GDP supplied
increases. If the price level falls relative to wages, profits
fall, the number of firms in business decreases, and the
quantity of real GDP supplied decreases.
In a severe recession, business failure can be
contagious. The failure of one firm puts pressure on both its
suppliers and its customers and can bring a flood of failures
and a large decrease in the quantity of real GDP supplied.
 Aggregate supply changes when any
influence on production plans other than
the price level changes. Aggregate supply
1.2 Changes in changes when
Aggregate Supply • Potential GDP changes
• The money wage rate changes
• The money price of other resources
change
CHANGES IN POTENTIAL GDP
Anything that changes potential GDP
changes aggregate supply and shifts the
aggregate supply curve. Figure 6.1 illustrates
such a shift. You can think of point C as an
anchor point. The AS curve and potential GDP
line are anchored at this, and when potential
GDP changes, aggregate supply changes along
with it. When potential GDP increases from P16
trillion to P17 trillion, point C shifts to point C,
and the AS curve and potential GDP line shift
rightward together. The AS curve shifts from AS,
to AS
CHANGE IN
MONEY WAGE
RATE
A change in the
money wage rate changes
aggregate supply because it
changes firms' costs. The
higher the money wage rate,
the higher are the firms'
costs and the smaller is the
quantity that firms are
willing to supply at each
price level. Soon as increase
in the money wage rate
decreases aggregate supply.
 Suppose that the money wage rate is P525 per day and the
price level is 105. Then the real wage rate is P500 per day (P525 x 100
÷ 105 = P500) - Unit 2. If the full employment equilibrium real wage
rate is P500 per day, the economy is at full employment and real GDP
equals potential GDP in Figure 6.2, the economy is at point C on the
aggregate supply curve AS The money wage rate is P525 per day at all
point on AS-
Now suppose the money wage rises to P575 per day but the
full-employment equilibrium real wage rate remains at P500 per day.
Real GDP now equals potential GDP when the price level is 115, at
point Don the aggregate supply curve AS2 (If the money wage rate is
P575 per day and the price level is 115, the real wage rate is P575 x 100
÷ 115 = P500 per day.) The money wage rate is P575 per day at all
points on AS2. The rise in the money wage rate decreases aggregate
supply and shifts the aggregate supply curve leftward from AS, to AS2
A change in the money wage rate does not change potential
GDP. The reason is that potential GDP depends only on the economy's
real ability to produce and on the full-employment quantity of labor,
which occurs at the equilibrium real wage rate. The equilibrium real
wage rate can occur at any money wage rate.
 A change in money prices of other resources has a similar effect on
firms' production plans to a change in the money wage rate. It changes
firms' costs. At each price level, firms 'real costs change and the quantity
that firms are willing to supply changes so aggregate supply changes.

Figure 6.2 A Change in the Money Wage Rate

CHANGE IN
MONEY PRICES
OF OTHER
RESOURCES
PRACTICE
PROBLEM 6.1
1. Explain the influence of each of the
events in List 1 on the quantity of real
GDP supplied and aggregate supply in
India and use a graph to illustrate.
List 1
 Fuel prices rise
 U.S. firms move their IT and data
functions to India
 Walmart and Starbucks open in
India
 Universities in India increase the
number of engineering graduates
 The money wage rate in India rises.
 The price level in India rises
2. In the News: South Korea
imports 97 percent of its
energy usage and is the
world's ninth biggest user of
oil. From June 2014 to
February 2015, the price of
crude oil almost halve.
Explain how the fall in the
price of oil will influence
South Korea's
KEY POINTS
01
Aggregate supply is the
relationship between the
quantity of real GDP supplied
and the price level when all
other influences on
production plans remain the
same.
02
The AS curve slopes upward
because with a given money
wage rate, a rise in the price
level lowers the real wage
rate, increases the quantity of
labor demanded, and
increases the quantity of real
GDP supplied.
03
A change in potential GDP, a
change in the money wage
rate, or a change in the money
price of other resources
changes aggregate supply.