A College Economics Guide
Supplementary resources for college students
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. That is, at a higher price level, the quantity of goods supplied in aggregate is higher. Alternatively, if businesses simultaneously tried to increase the quantity of goods they supplied, they would have to hire more workers or buy more software or equipment. This would drive up the cost of production, which in turn would mean a higher price level.
Although the word “aggregate” makes it sound as if something economists call “aggregate supply” should be the sum of all of a country’s supply curves, it is not exactly that. Because you can’t add apples and oranges–much less add apples and haircuts, or apples and cars–the number of goods such as apples, oranges, haircuts, cars, etc. that are supplied within a country is a bit more abstract.
Consequently, aggregate supply is more accurately described as a relationship between the price level and real GDP–which is the value of all the goods and services produced in the economy divided by the price level. In easier terms, you can think of it as a relationship between the average price per good and the quantity of goods of average value.
The concept economists are trying to get at when they use the term aggregate supply is close to the idea of summing up all of a country’s supply curves. The idea of aggregate supply is a helpful shorthand for thinking about an economy as a whole in a succinct way, even if it turns out to be difficult to measure.
The concept of aggregate supply is most often used in discussions about a business cycle. Suddenly rising prices signal businesses to expand production quickly by, say, hiring more workers or buying more software or equipment right away.
Definitions and Basics
Aggregate Supply. An Economics Topics Detail.
Aggregate supply is the relationship between the overall price level in the economy and the amount of output that will be supplied. As output goes up, prices will be higher.
New Classical Macroeconomics, from the Concise Encyclopedia of Economics
Shocks to aggregate supply are typically changes in productivity that may result, for example, from transient changes to technology, prices of raw materials, or the organization of production. Ideally, firms would choose to produce more and to pay their workers more when the economy has been hit by favorable shocks and less when hit by unfavorable shocks. Similarly, workers would be willing to work more when productivity and wage rates are higher and to take more leisure when their rewards are lower. For both, the rule is “make hay while the sun shines.”…
National Income Accounts, from the Concise Encyclopedia of Economics
The broadest and most widely used measure of national income is gross domestic product (GDP), the value of expenditures on final goods and services at market prices produced by domestic factors of production (labor, capital, materials) during the year. It is also the market value of these domestic-based factors (adjusted for indirect business taxes and subsidies) entering into production of final goods and services. “Gross” implies that no deduction for the reduction in the stock of plant and equipment due to wear and tear has been applied to the measurements and survey-based estimates. “Domestic” means that the GDP includes only production by factors located in the country–whether home or foreign owned. GDP includes the production and income of foreigners and foreign-owned property in the home country and excludes the production and incomes of the country’s own citizens or their property located abroad….
In the News and Examples
OPEC, from the Concise Encyclopedia of Economics
Despite what many noneconomists believe, the 1973-1974 price increase was not caused by the oil “embargo” (refusal to sell) that the Arab members of OPEC directed at the United States and the Netherlands. Instead, OPEC reduced its production of crude oil, raising world market prices sharply. The embargo against the United States and the Netherlands had no effect whatsoever: people in both nations were able to obtain oil at the same prices as people in all other nations. This failure of the embargo was predictable, in that oil is a “fungible” commodity that can be resold among buyers….
Inflation, from the Concise Encyclopedia of Economics
Some economists call the above analysis a “demand-pull” explanation (monetary expansion fuels spending that pulls prices up), while proposing a “cost-push” alternative. For particular episodes of inflation, they have variously blamed monopolies, labor unions, OPEC, and even the failure of the anchovy harvest off Peru for pushing up prices. The equation of exchange warns us that for a “supply shock” to account for a large rise in the general price level (not just a relative rise in some prices, such as the price of oil), the economy’s output must shrink by a large percentage. In practice, “supply shock” cases are seldom large enough to account for much inflation and are typically short-lived….
A Little History: Primary Sources and References
Jean-Baptiste Say, biography from the Concise Encyclopedia of Economics
Say’s Law has various interpretations. The long-run version is that there cannot be overproduction of goods in general for a very long time because those who produce the goods, by their act of producing, produce the purchasing power to buy other goods. Say wrote: “How could it be possible that there should now be bought and sold in France five or six times as many commodities as in the miserable reign of Charles VI?” With this statement Say had the long run in mind. Certainly the long-run version is correct. Given enough time, supply does create its own demand. There can be no long-run glut of goods.
But Say also had a short-run version, that even in the short run there could be no overproduction of goods relative to demand. It was this version that Malthus attacked in the nineteenth century and that Keynes attacked in the twentieth century. They were right to attack it….