What is Aggregate Supply?

//What is Aggregate Supply?
What is Aggregate Supply? 2017-09-30T05:39:40+00:00

Definition: Aggregate supply (AS) is the total real output of goods and services, including consumer goods and capital goods, that firms produce and supply at a given price level during a specified period of time.

What Does Aggregate Supply Mean?

What is the definition of aggregate supply? The aggregate supply curve show that at a higher price level across the economy, firms are expected to supply more of their goods and services at higher prices. Any increase in the costs of production lead to an increase in the general price level and therefore, firms expect that they will benefit from higher prices, at least in the short-run.

In this context, modern economists separate the short-term aggregate supply from the long-term aggregate supply because the short-term AS begins following an increase in the general price level and ends when the cost of production has increased.

This allows the firms to produce more output, therefore increasing the aggregate supply. In contrast, the long-term AS is related only to improvements in productivity and efficiency, and not to the general price level.

Let’s look at an example.

Example

Manufacturing firms supply 100 tons of a particular good when the production costs total to $376,000. If the production costs rise to $581,000, these firms will be required to lower the supply of this particular good because the general price level of the economy will rise. At the same time, the labor costs total up to $30,500.

If the labor costs rise to $41,200, the firms will lower their production. Furthermore, if these firms are importing raw materials, an increase in the exchange rates will cause the prices of raw materials to rise, and vice versa. On the other hand, a decrease in an import tariff will cause a rise in aggregate supply.

Assume that the government imposes a green tax to protect the environment. This will cause higher costs for the firms, especially those involve in carbon emissions. On the other hand, a lower tax on oil would increase the aggregate supply of oil products, as the firms involved in the oil production will have lower costs, therefore increasing their output.

Summary Definition

Define Aggregate Supply: The aggregate supply is total amount of goods and services the market is willing to produce at a specific price as demonstrated on the aggregate supply curve.