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FOREIGN EXCHANGE: Any financial instrument that gives one country a claim on the currency of another country and which is used to make payments between countries. The most important type of foreign exchange is currency itself, that is, the currency of other countries. However foreign exchange also includes things like bank checks and "bills of exchange" (a sort of contract that's paid for with the currency of one nation that can be then traded for the currency of another country).

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AGGREGATE SUPPLY DETERMINANTS:

An assortment of ceteris paribus factors that affect short-run and long-run aggregate supply, but which are assumed constant when the short-run and long-run aggregate supply curves are constructed. Changes in any of the aggregate supply determinants cause the short-run and/or long-run aggregate supply curves to shift. While a wide variety of specific ceteris paribus factors can cause the aggregate supply curves to shift, they are commonly grouped into three broad categories--resource quantity, resource quality, and resource price.
Aggregate supply determinants are held constant when the aggregate supply curves are constructed. A change in any of these determinants causes a shift of either the short-run aggregate supply curve, the long-run aggregate supply curve, or both.

The assortment of aggregate supply determinants fall into three categories (1) resource quantity--the amounts of labor, capital, land, and entrepreneurship available, (2) resource quality--the productivity of the four factors of production, and (3) resource price--the prices of the inputs used in production.

While a complete list is lengthy, four specific determinants that tend to stand out in the study of macroeconomics and aggregate market (AS-AD) analysis are:

  • Wages: This is the price of labor, which works through the resource price determinant. It is the key determinant underlying the self-correction mechanism of the aggregate market. Wages affect the short-run aggregate supply curve, but not the long-run aggregate supply curve.

  • Technology: Improvements in production techniques, often embodied in product inventions and innovations, is a prime example of a resource quality determinant. Technology causes shifts in both the short-run and long-run aggregate supply curves.

  • Energy Prices: These are the prices of key energy inputs, especially petroleum, that are essential to any modern industrialized economy. Like wages, energy prices also work through the resource price determinant. Also like labor, energy prices affect the short-run aggregate supply curve, but not the long-run aggregate supply curve.

  • Capital Stock: This is the total quantity of capital used by the economy for production. It is a prime example of a resource quantity determinant and affects both the short-run and long-run aggregate supply curves.
Other determinants of aggregate supply, each important in its own right, include education',500,400)">education, population growth, labor-force participation, resource exploration, and assorted material input prices.

Shifting the Aggregate Supply Curves

Shifting the SRAS Curve
Shifting the SRAS Curve

Shifting the LRAS Curve
Shifting the LRAS Curve

The aggregate supply determinants shift both the short-run aggregate supply curve, abbreviated SRAS, and the long-run aggregate supply curve, abbreviated LRAS. The exhibit to the right presents a standard short-run aggregate supply curve in the top panel and a typical long-run aggregate supply curve in the bottom panel.
  • The short-run aggregate supply curve is positively sloped and captures the specific one-to-one relationship between the price level and real production.

  • The long-run aggregate supply curve is vertical at the full-employment level of production, indicating that real production is independent of the price level.
The ceteris paribus factors, that is, the aggregate supply determinants, are assumed to remain constant when these curves are constructed. Similar to other determinants, the aggregate supply determinants shift these two aggregate supply curves. A change in any of the determinants can increase or decrease one or both of the aggregate supply curves.
  • Short-Run Aggregate Supply: Consider first the short-run aggregate supply curve. An increase in short-run aggregate supply is illustrated by a rightward shift in the SRAS curve in the top panel. A decrease in short-run aggregate supply is illustrated by a leftward shift. Click the [Increase in SRAS] or [Decrease in SRAS] buttons for a demonstration.

  • Long-Run Aggregate Supply: Now consider the long-run aggregate supply curve. An increase in long-run aggregate supply is illustrated by a rightward shift in the LRAS curve in the bottom panel. A decrease in long-run aggregate supply is illustrated by a leftward shift. Click the [Increase in LRAS] or [Decrease in LRAS] buttons for a demonstration.
What does it mean to have an increase in supply? It means that for every price level, the business sector is willing and able to supply more real production. A decrease in supply is obviously the exact opposite. For every price level, the business sector is willing and able to supply less real production.

Three Determinants

Consider how the three basic determinants--resource quantity, resource quality, and resource price--affect the aggregate supply curves. Also note a few examples falling into each category.

Resource Quantity: The first major determinant is the quantity of resources--labor, capital, land, and entrepreneurship--that the economy has available for production. This determinant causes shifts of both the SRAS and LRAS curves. Quite simply, if the economy has more resources, then aggregate supply increases and both aggregate supply curves shift rightward. With fewer resources, aggregate supply decreases and both curves shift leftward.

Some of the specific determinants that can cause changes in resource quantity include:

  • Population: The total size of the population, which is affected by births, deaths, and migration, is a key influence on the quantity of labor. A larger population means more potential workers. While population generally increases through both natural growth and immigration, it can decrease as well. Reasons for a declining population including emigration, wars, famines, diseases, and natural disasters.

  • Labor Force Participation Rate: The labor force participation rate is another key influence on the labor quantity. A change in the proportion of a given population that is willing and able to work changes the labor force and shifts the aggregate supply curves. The U.S. economy, for example, has seen an increase in its labor force participation rate over the last 50 years largely through an increase in the proportion of women in the labor force.

  • Capital Stock: Changes in the economy's stock of capital is the most important influence on the quantity of capital. These changes are brought about through a combination of investment and depreciation. Investment adds to the capital stock and depreciation reduces it. Investment has the curious role of affecting both the aggregate demand curve, as one of the four aggregate expenditures, and the aggregate supply curves, by influencing the capital stock.

  • Exploration: Discovering new sources of raw materials or other natural resources influences the quantity of land. While the economy is unlikely to "discover" large masses of land like explorers did a few centuries back, exploration does identify mineral deposits, fossil fuel reserves, and other natural resources that increases the aggregate supply curves. Alternatively, depletion of existing natural resources causes a decrease in the aggregate supply curves.
Resource Quality: The second major determinant of the aggregate supply curves is the quality of resources. If the quality of labor, capital, land, and entrepreneurship changes, then the SRAS and LRAS curves shift. An improved quality increases aggregate supply and a decline in quality decreases aggregate supply.

Two specific determinants that affect resource quality are education and technology.

  • Education: Education includes formal, college-type, get-a-degree education, and informal on-the-job training and learn-by-doing experiences. Education affects the quality of labor. Higher quality labor, brought about by more education, is more productive and causes the aggregate supply curves to increase. Of course, it is also possible for less education to reduce the quality of labor and cause the aggregate supply curves to decrease.

  • Technology: Technology is the information that the economy has concerning production techniques. Technology generally affects the quality of capital, but can also peripherally affect the quality of labor, land, and entrepreneurship. In modern times, technology has invariably advanced, causing increases in the quality of capital and thus increases in aggregate supply. It is, however, possible for a technological backstep that would cause a decrease in the quality of capital and aggregate supply.
Resource Price: The third major aggregate supply determinant is resource price. The prices of resource affect the cost of producing output and thus the price level charged for an existing quantity of real production. This determinant ONLY affects the short-run aggregate supply. Because the long-run aggregate supply is independent of the price level it is also unaffected by changes in resource prices and production cost.

Two of the more important resource prices that influence production cost and shift the SRAS curve are:

  • Wages: Wage payments to labor are usually at the top of any list of resource prices. Wages account for about 60 percent of production cost of the economy. Economy-wide changes in wages shift the SRAS curve. Higher wages, by increasing production cost, cause a decrease short-run aggregate supply. Lower wages, by decreasing production cost, cause an increase short-run aggregate supply.

  • Energy Prices: Energy prices, especially petroleum prices, are a second key group of resource prices. Because energy, like labor, is critical in the production of virtually every good and service in the economy, changes in energy prices also tend to shift the SRAS curve. Like wages, higher energy prices increase production cost and cause a decrease short-run aggregate supply. Lower energy prices decrease production cost and cause an increase short-run aggregate supply.

Two Changes

Shifts of the short-run or long-run aggregate supply curve, brought about by such things as education or technology, an increase in the size of the population or the capital stock, or changes in wages or energy prices, can be the source of disequilibrium in the aggregate market. Such disequilibrium then results in changes in the price level. The key is that aggregate supply determinants CAUSE shifts of the aggregate supply curves which CAUSE disequilibrium which then CAUSES changes in the price level.

This suggests an important difference between two related changes--a change in aggregate supply and a change in real production.

  • A change in aggregate supply is any shift of either of the aggregate supply curves. With this change, the entire curve shifts to a new location. A change in aggregate supply is caused by a change in the aggregate supply determinants. This is comparable to a change in supply in the analysis of the market.

  • A change in real production is a movement along a given aggregate supply curve. This change involves the movement from one point on the existing curve to another point on the SAME curve. The curve does not move. A change in real production is caused by a change in the price level, and ONLY a change in the price level! This is comparable to a change in quantity supplied in the analysis of the market.

    While a change in real production, as a movement along the curve, applies in principle to both short-run and long-run aggregate supply curves, because real production does not change in the long run, from a practical standpoint, a change in real production primarily applies to the short-run aggregate supply curve.

<= AGGREGATE SUPPLY DECREASE, SHORT-RUN AGGREGATE MARKETAGGREGATE SUPPLY INCREASE, LONG-RUN AGGREGATE MARKET =>


Recommended Citation:

AGGREGATE SUPPLY DETERMINANTS, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2014. [Accessed: October 24, 2014].


Check Out These Related Terms...

     | change in aggregate supply | change in real production | aggregate supply shifts | slope, aggregate supply curve | resource quantity, aggregate supply determinant | resource quality, aggregate supply determinant | resource price, aggregate supply determinant | wages, aggregate supply determinant | energy prices, aggregate supply determinant | technology, aggregate supply determinant | capital stock, aggregate supply determinant | aggregate demand determinants |


Or For A Little Background...

     | aggregate supply | short-run aggregate supply | long-run aggregate supply | short-run aggregate supply curve | long-run aggregate supply curve | gross domestic product | price level | real production | GDP price deflator | real gross domestic product | production cost |


And For Further Study...

     | AS-AD analysis | aggregate market | business cycles | circular flow | Keynesian economics | monetary economics | flexible prices | inflexible prices | short-run aggregate supply and market supply | aggregate market shocks |


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