June 14, 2024 

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SAY'S LAW: A classical economic proposition stating that the production of aggregate output creates sufficient aggregate demand to purchase all of the output produced. In other words, supply creates its own demand. This is one of the three assumptions underlying the macroeconomic theory of classical economics which concluded that unrestricted market activity would generate full employment. The other two assumptions are flexible prices and saving-investment equality. Say's law is closely associated with the circular flow model.

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An economic model relating the price level and real production that is used to analyze business cycles, gross production, unemployment, inflation, stabilization policies, and related macroeconomic phenomena. The aggregate market, inspired by the standard market model, but adapted to the macroeconomy, captures the interaction between aggregate demand (the buyers) and short-run and long-run aggregate supply (the sellers). Also known by the names AS-AD model or income-price model, the aggregate market is THE cornerstone model of macroeconomic analysis.
The aggregate market model combines the aggregate demand of the four macroeconomic sectors--household, business, government, and foreign--with the aggregate supply of real production (long run and short run). This model emerged onto the theoretical scene in the 1970s, replacing the Keynesian economic model that dominated macroeconomics from the 1940s to the 1970s. In its present form, it provides a general model of the economy that can be used to explain and understand periods of both contractionary unemployment and expansionary inflation. It incorporates the importance of aggregate demand, emphasized by Keynesian economics, as well as aggregate supply, emphasized by classical economics.

The extended name for this model is the aggregate product market, to emphasize that it reflects the exchange of gross domestic product in the macroeconomic product markets. However, the two other basic macroeconomic markets--financial markets and resource markets--play key roles behind the scenes and close to the surface of the aggregate market.

The Basic Graphical Model

The Aggregate Market
The Aggregate Market
The exhibit to the right illustrates the basic components of the aggregate market. The vertical axis measures the price level (GDP price deflator) and the horizontal axis measures real production (real GDP). The negatively-sloped curve, labeled AD, is the aggregate demand curve; the positively-sloped curve, labeled SRAS, is the short-run aggregate supply curve; and the vertical curve, labeled LRAS, is the long-run aggregate supply curve.

The analytical value of this model results from identifying the equilibrium price level and real production. Then perhaps more informative, the model is used analyze shifts of these three curves and how the shifts affect the equilibrium price level and real production. In so doing implications about unemployment, inflation, income, and other macroeconomic activity can be obtained.

Inspired by the Market

Like the standard market model used in microeconomics, the aggregate market captures price and quantity interactions between buyers and sellers. There are, however, two key differences.
  • One key difference is the measurement units. The "price" in the aggregate market is actually the price level, usually measured by the GDP price deflator, and the "quantity" is real production, usually measured by real gross domestic product (real GDP).

  • Another key difference is the supply-side of the model. The supply-side of the aggregate market is divided into short-run aggregate supply and long-run aggregate supply. The difference between these two is based on price flexibility, or the time required for prices to adjust to equilibrium levels. The long-run aggregate supply presumes that ALL prices are flexible, while the short-run aggregate supply presumes that some prices, especially resource prices, are inflexible.

Going Long and Short

The Long-Run Aggregate Market
The Aggregate Market
The Short-Run Aggregate Market
The Aggregate Market
The separation of the supply-side of the aggregate market into long-run and short-run aggregate supply gives rise to two aggregate market "submodels," the long-run aggregate market and the short-run aggregate market.
  • Long-Run Aggregate Market: The long-run aggregate market, presented in the top panel of the exhibit to the right, isolates the interaction between aggregate demand and long-run aggregate supply. The key assumption of this model is that ALL prices, especially resource prices, are flexible. This gives rise to the vertical long-run aggregate supply curve. The primary result of this model is that the economy achieves long-run equilibrium at full-employment real production.

  • Short-Run Aggregate Market: The short-run aggregate market, presented in the bottom panel of the exhibit to the right, isolates the interaction between aggregate demand and short-run aggregate supply. The key assumption of this model is that some prices, especially resource prices, are inflexible. This generates the positively-sloped short-run aggregate supply curve. The primary result of this model is that the economy can achieve short-run equilibrium at real production levels that are greater or less than full employment.
Whether long-run or short-run, full-employment takes center stage in the aggregate market. In the long-run aggregate market, real production achieves full employment regardless of changes in aggregate demand or the price level. In the short-run aggregate market, however, equilibrium can occur at production levels greater or less than full employment.

In particular, an inflationary gap results if short-run equilibrium production exceeds full employment and a recessionary gap occurs if production falls short of full employment. These output gaps not only illustrate the essence of business-cycle instability, but also suggest the role stabilization policies can play in achieving full employment.

Three Markets In One

To be technically precise, the aggregate market is the aggregate "product" market. Including this extra term highlights the fact that the aggregate market is the aggregation of the economy's product markets, markets that exchange final goods and services, or gross domestic product. However, two other aggregated macroeconomic markets, financial and resource, are also working behind the scenes of the aggregate market.
  • Financial markets provide the liquidity (money and loans) that buyers use to purchase the production.

  • Resource markets provide the inputs (labor, capital, land, and entrepreneurship) that producers need to supply the production.
These three markets give rise to two notions of equilibrium for the aggregate market--long-run equilibrium and short-run equilibrium.
  • Long-run equilibrium is based on equilibrium in ALL three aggregate markets, product, financial, and resource.

  • Short-run equilibrium, in contrast, is based on equilibrium in the product and financial markets, but disequilibrium in the resource markets.
The difference between long-run and short-run equilibrium takes center stage in most of the analysis, policy, and controversy of macroeconomics. The existence and persistence of short-run equilibrium gives rise to recessionary and inflationary gaps, with the associated problems of unemployment and inflation, and suggests a key role for government stabilization policies. Long-run equilibrium, in contrast, implies a healthy, prosperous, problem free economy that needs no government intervention.


Recommended Citation:

AGGREGATE MARKET, AmosWEB Encyclonomic WEB*pedia,, AmosWEB LLC, 2000-2024. [Accessed: June 14, 2024].

Check Out These Related Terms...

     | aggregate market analysis | long-run aggregate market | short-run aggregate market | equilibrium, aggregate market | equilibrium, long-run aggregate market | equilibrium, short-run aggregate market |

Or For A Little Background...

     | aggregate demand | aggregate supply | aggregate expenditures | macroeconomic sectors | long-run aggregate supply | short-run aggregate supply | aggregate demand curve | long-run aggregate supply curve | short-run aggregate supply curve | price level | GDP price deflator | real gross domestic product | market |

And For Further Study...

     | disequilibrium, aggregate market | disequilibrium, long-run aggregate market | disequilibrium, short-run aggregate market | output gaps | recessionary gap | inflationary gap | aggregate market shocks | self correction, aggregate market | Keynesian economics | monetary economics | classical economics |

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