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REAL WAGE: The inflation-adjusted purchasing power of the nominal wage. The real wage is commonly derived by dividing the nominal wage by the price level, indicates the physical quantities of goods and service that can be purchased with the nominal wage.

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AGGREGATE SUPPLY:

The total (or aggregate) real production of final goods and services available in the domestic economy at a range of price levels, during a given time period. Aggregate supply, usually abbreviated AS, is two different relations between price level and real production--long run and short run. With long-run aggregate supply, prices and wages are flexible and all markets are in equilibrium. With short-run aggregate supply some prices and wage are NOT flexible and some markets are NOT in equilibrium. This is one half of the AS-AD (aggregate market) analysis. The other half is aggregate demand.
Aggregate supply is the total production of gross domestic product. It relates the economy's price level, usually measured by the GDP price deflator, and domestic production, usually measured by real gross domestic product. The aggregate supply exhibits a different relation between real production and price level in the short run and the long run. The relation is direct in the short run--a higher price level is related to an increase in real production and a lower price level is related to a decrease in real production. The relation is independent in the long run--a higher or lower price level is related to the same level of real production.

The role played by aggregate supply in the aggregate market analysis is analogous to the role played by market supply',500,400)">market supply in the standard market analysis. Both represent the "selling side" of the market. Both relate price and quantity. However, differences emerge because aggregate supply is for ALL production in the economy, while market supply is that for a single product. Moreover, aggregate supply actually consists of two separate relations, short run and long run. While the short-run aggregate supply curve is positively-sloped for reasons similar to that for the market supply curve, the long-run aggregate supply curve is vertical.

A closer inspection of aggregate supply involves four specific topics: (1) the role aggregate supply plays in the aggregate market, (2) the two aggregate supply curves--long run and short run, (3) the difference between the short run and the long run, and (4) measures of real production and the price level.

Aggregate Market

Aggregate supply is an integral part of the AS-AD (aggregate market) analysis. The aggregate market is a handy model of the macroeconomy designed to analyze the relationship between total production (real gross domestic product) and the price level (the GDP price deflator). Without the aggregate supply side of the model, very little analyzing can be accomplished. In the same way that the standard market analysis is based on the interaction between market supply and market demand, the aggregate market analysis is based on the interaction between aggregate supply and aggregate demand. There is NO analysis without both.

The aggregate market analysis is used to understand assorted macroeconomic events, especially business cycles, inflation, and unemployment. It is also used to analyze the effects of assorted government policies designed to achieve the macroeconomic goals of full employment, stability, and economic growth. The aggregate market is currently THE standard model for macroeconomic analysis.

Long Run and Short Run

Two time designations are used in the study of aggregate supply--long run and short run. The long run is a period of time in which all prices are flexible. The short run is a period of time in which some prices are flexible and some are rigid. Long run price flexibility means that all resource, product, and financial markets are in equilibrium. Short run price rigidity means disequilibrium in resource markets, even though product and financial markets are in equilibrium.

In particular, labor resource markets can be out of equilibrium, with differences between quantity supplied and quantity demanded (surpluses or shortages), even though the product markets are in equilibrium. The household, business, government, and foreign sectors are able to buy all that they want, and producers find buyers for all that they produce, but some workers are unemployed or some jobs remain unfilled.

  • Long Run: In the long run all prices are flexible. Price flexibility ensures that all markets are in equilibrium. Prices rise to eliminate market shortages and fall to eliminate market surpluses. The end result is equilibrium--FOR ALL MARKETS. This conclusion is particularly important for resource markets, especially labor. No surplus in the labor market, means that no workers are seeking jobs that do not exist. There is no cyclical unemployment. And no cyclical unemployment means full employment. The long run is characterized by both flexible prices and full employment.

  • Short Run: In the short run, some prices are flexible and some are rigid. Prices most likely to be rigid in the short run are those for resources, especially wages. Wage rigidity means that labor market shortages and surpluses are not necessarily eliminated and that the labor market is not necessarily in equilibrium. The most notable importance of wage rigidity is shortages in labor and other resource markets, and shortages mean cyclical unemployment.

Two Aggregate Supply Curves

Two Aggregate Supply Curves
Two Aggregate Supply Curves

The supply side of the aggregate market is captured by two separate curves--one for the long run and one for the short run. The exhibit to the right is waiting to display both curves. Before revealing the aggregate supply curves, first note that the price level is measured on the vertical axis and real production is measured on the horizontal axis. The price level is measured by the GDP price deflator and real production is measured by real GDP.
  • Long Run: The long run is characterized by flexible prices and equilibrium in production, financial, and resource markets. This means that resources, especially labor, have full employment. Flexible prices mean that full employment is achieved and maintained, regardless of the price level. As a result, the long-run aggregate supply curve is vertical at the quantity of real production generated at full employment. To reveal this curve click the [Long Run] button.

  • Short Run: The short run is characterized by inflexible prices and disequilibrium in resource markets, either surplus or shortage. This means that resources, especially labor, have either cyclical unemployment or overemployment. Inflexible prices mean that real production is responsive to the price level. A higher price level induces an increase in real production, as employment increases, and a lower price level induces a decrease in real production, as employment decreases. As a result, the short-run aggregate supply curve is positively sloped. To reveal this curve click the [Short Run] button.
Before leaving these curves, make note of a couple of points:
  • First, the price level and aggregate expenditures on real production are the only two variables allowed to change in the construction of these curves. Everything else that could affect aggregate supply is assumed to remain constant. Analogous to market supply, these other variables are ceteris paribus factors that fall under the heading of aggregate supply determinants.

  • Second, these aggregate supply curves capture the relation between the price level and real production during a given time period, usually one year. However, depending on the particular aggregate market analysis, the time period could be shorter (one month or one quarter) or longer (several years).

Real Production

Aggregate supply is the total real production available in the domestic economy. The two key dimensions of this are "total" and "real."
  • Because aggregate supply is the supply for the entire economy it is necessarily the TOTAL production of goods and services. It includes the production and supply of consumption goods, capital goods, exported goods, and goods purchased by the government sector.

  • In addition, aggregate supply is the supply of REAL production. It is the physical production, the quantities of goods and services produced that is unrelated to, or unaffected by, nominal price changes.
The standard measure of real production is real gross domestic product or real GDP, which is the total market value, measured in constant prices, of all goods and services produced within the boundaries of an economy during a given period of time, usually one year. Real GDP measures the physical production in the economy after it is adjusted for inflation or price changes. This is the best available indicator of expansions, contractions, and business-cycle instability that tend to come under the greatest analytical focus of the aggregate market.

Price Level

Aggregate supply is the supply of real production at different price levels. The price level is essentially the price of the final goods and services produced in the economy, that is, the price of real production. However, because the economy produces thousands of different goods and services, the price level is actually an average of thousands of different prices. The price level is commonly measured using one of two price index averages.
  • Consumer Price Index: The most widely recognized measure of the price level is the Consumer Price Index (CPI). The CPI is an average of the prices of the goods typically purchased by urban consumers. While it is a relatively good indicator of the price level, it does not include the prices of goods typically purchased only by rural consumers or the business, government, and foreign sectors, which constitute about 40 percent of gross domestic product.

  • GDP Price Deflator: The price index generally prefer by economists is the GDP price deflator. The GDP price deflator is a bi-product from the calculation of real GDP, which makes it an average of the prices of ALL final goods and services produced in the economy, including those purchased by all households (urban and rural), as well as the business, government, and foreign sectors. It is the preferred index for measuring the price level used in the aggregate market analysis and aggregate supply because it provides a comprehensive coverage of production.
The price level is also key to distinguishing between two similar concepts--aggregate supply and real production. While aggregate supply and real production might seem like the same concept, they are not. In fact, the difference between aggregate supply and real production is analogous to the difference between supply and quantity supplied.
  • Aggregate Supply: This is the range of real production supplied at different price levels. It includes an assortment of price level-real production combinations. This is comparable to supply.

  • Real Production: This is the total quantity of goods and services produced by the domestic economy at a specific price level. This is comparable to quantity supplied.
Real production is the quantity of output produced (like the quantity supplied) at a specific price level. Aggregate supply (like market supply) includes all price-quantity pairs, that is, all price level-real production pairs. Key to this difference is that a change in the price level causes a change in real production (at least in the short run). A change in any factor other than the price level causes a change in aggregate supply.

Other Supplies

Aggregate supply is one of several types of "supply" in the study of economics. When economists speak of "supply" with no modifiers, they are usually referring to "market supply." In addition to market supply and aggregate supply, two other types of supply include factor supply, which is the supply of the services of factors of production, and money supply, which is the supply of money circulating around the economy.

<= AGGREGATE MARKET SHOCKSAGGREGATE SUPPLY DECREASE, LONG-RUN AGGREGATE MARKET =>


Recommended Citation:

AGGREGATE SUPPLY, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2014. [Accessed: July 27, 2014].


Check Out These Related Terms...

     | aggregate supply curve | aggregate supply determinants | aggregate supply | aggregate market analysis | aggregate market | short-run aggregate supply | long-run aggregate supply | short-run, macroeconomics | long-run, macroeconomics |


Or For A Little Background...

     | macroeconomics | gross domestic product | price level | price index | macroeconomic theories | macroeconomic markets | macroeconomic sectors | supply | Consumer price Index | GDP price deflator | real gross domestic product | National Income and Product Accounts | full employment | unemployment |


And For Further Study...

     | change in aggregate supply | change in real production | aggregate supply shifts | slope, short-run aggregate supply curve | slope, long-run aggregate supply curve | business cycles | circular flow | Keynesian economics | monetary economics | short-run aggregate supply and market supply |


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