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

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

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

• 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.

• 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

• 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.

Price Level

• 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.

• 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.

Other Supplies