Aggregate SupplyDefined along with Examples

Written By:
Lisa Borga

What is Aggregate Supply?

Aggregate supply, or total output as it is also known, refers to the total amount of goods and services an economy produces over a given period of time at a particular price.

This is often represented by a supply curve which measures the amount that suppliers are willing to provide at a given price.

Generally, if all other factors remain the same as price rises, so will the amount that suppliers are willing to provide, and as price falls, so too will supply.

This is typically measured over a year because suppliers need time to adjust production in response to changes in demand.

Understanding Aggregate Supply

Aggregate supply is the total amount of goods or services that are supplied in an economy at a given price level.

At a given price level, if demand were to increase, then consumers would need to compete for the amount of the good that is available, and as a result, prices would increase.

When prices rise, firms know to respond by increasing their production to meet the rising demand.

When supply increases sufficiently to meet demand, the price will stabilize, and output will remain at this level.

However, other factors can influence aggregate supply as well.

Changes on the suppliers’ side, such as the quantity of available labor, changes in wages, advancements in technology, taxation, subsidies, and inflation, among others, can affect aggregate supply.

Some of these changes could increase aggregate supply, and others would cause it to decline.

For example, a new technological development in automation may allow a firm to produce more of a good or service by reducing the cost of labor.

Conversely, an increase in minimum wage could increase the cost of labor and, as a result, total production costs for some suppliers reducing aggregate supply.

Short-Term Vs. Long-Term Aggregate Supply

Over the short term, suppliers will respond to an increase in price by increasing their output through altering variable factors of production.

This includes increases in labor, such as asking workers to perform overtime and using more of the raw materials that are available.

However, in the short term, there is a limit on how much a firm can do to increase production.

For example, a company could not build new factories or develop new technologies, plus there are likely to be limits on the availability of raw materials.

Instead, a company is limited by the factors of production they already have available.

However, in the long term, a supplier is much more capable of adjusting factors of production.

A supplier could, for instance, build more factories or invest in research and development in order to develop new ways to produce products more efficiently.

As a result, over a long enough time frame, long-term supply will only be affected by changes in productivity rather than by price level.

The Four Factors of Production and Aggregate Supply

In the long term, aggregate supply is determined by the presence of the four factors of production.

When any of these factors are deficient, aggregate supply will suffer.

These four factors include:

• Labor: Production requires labor in order to create goods or services. The value of any given labor depends upon the skill and motivation of the workers. Up to a point, efficiency may be able to be raised by providing greater education or incentive for workers.
• Capital: Capital includes all of the capital goods such as tools and machinery which are used to produce a good or service. This may include equipment used to produce a product or a dentist’s X-ray machine.
• Land: Land includes all of the many natural resources that may be used to help produce goods or services in addition to real estate. This may include agricultural products or minerals and other resources that can be extracted from it.
• Entrepreneurship: Entrepreneurs are those who utilize the other factors of production in order to drive innovation and supply goods or services. This is a necessary component of economic activity and production.

Example of Aggregate Supply

As an example, consider ABC Company which produces a handheld gaming console.

The introduction of a popular new game creates a sudden increase in demand for the console, causing a shortage of supply and increased prices.

In response, the ABC Company pays its workers for overtime to produce more of the console.

The increase in production allows aggregate supply to meet the demand, and the price will remain stable at this point until demand declines.

At this point, retailers would likely reduce the price, and the aggregate supply would again change.

Key Takeaways

• Aggregate supply is the relationship between the overall production of an economy and the price point for a specified period of time.
• Over the short-term, aggregate supply will primarily be affected by changes in demand, whereas over the long-term, changes in productivity.
• Aggregate supply is generally measured over a year because aggregate supply changes more slowly than aggregate demand.