Aggregate demand and aggregate supply curves (article) | Khan Academy
The supply curve represents the relationship between price and quantity supplied, with all other factors affecting supply held constant. What happens when a. The short-run aggregate supply curve represents the relationship between the total quantity of final goods and services that suppliers are willing and able to. True or False: An increased price level reduces the quantities of investment The short-run aggregate supply curve represents the relationship between the.
Aggregate demand and aggregate supply curves
Price level is the average price of all goods and services produced in the economy. It's an index number, like the GDP deflator.
Wait, what's a GDP deflator again? The GDP deflator is a price index measuring the average prices of all goods and services included in the economy. Notice on the graph that as the price level rises, the aggregate supply—quantity of goods and services supplied—rises as well.
Why do you think this is? The price level shown on the vertical axis represents prices for final goods or outputs bought in the economy, not the price level for intermediate goods and services that are inputs to production. The AS curve describes how suppliers will react to a higher price level for final outputs of goods and services while the prices of inputs like labor and energy remain constant.
If firms across the economy face a situation where the price level of what they produce and sell is rising but their costs of production are not rising, then the lure of higher profits will induce them to expand production. Potential GDP If you look at our example graph above, you'll see that the slope of the AS curve changes from nearly flat at its far left to nearly vertical at its far right. At the far left of the aggregate supply curve, the level of output in the economy is far below potential GDP—the quantity that an economy can produce by fully employing its existing levels of labor, physical capital, and technology, in the context of its existing market and legal institutions.
At these relatively low levels of output, levels of unemployment are high, and many factories are running only part-time or have closed their doors. In this situation, a relatively small increase in the prices of the outputs that businesses sell—with no rise in input prices—can encourage a considerable surge in the quantity of aggregate supply—real GDP—because so many workers and factories are ready to swing into production.
As the quantity produced increases, however, certain firms and industries will start running into limits—for example, nearly all of the expert workers in a certain industry could have jobs or factories in certain geographic areas or industries might be running at full speed. In the intermediate area of the AS curve, a higher price level for outputs continues to encourage a greater quantity of output, but as the increasingly steep upward slope of the aggregate supply curve shows, the increase in quantity in response to a given rise in the price level will not be quite as large.
At the far right, the aggregate supply curve becomes nearly vertical. At this quantity, higher prices for outputs cannot encourage additional output because even if firms want to expand output, the inputs of labor and machinery in the economy are fully employed. In our example AS curve, the vertical line in the exhibit shows that potential GDP occurs at a total output of 9, When an economy is operating at its potential GDP, machines and factories are running at capacity, and the unemployment rate is relatively low at the natural rate of unemployment.
The aggregate supply curve is typically drawn to cross the potential GDP line. This shape may seem puzzling—How can an economy produce at an output level which is higher than its potential or full-employment GDP?
The economic intuition here is that if prices for outputs were high enough, producers would make fanatical efforts to produce: Such hyper-intense production would go beyond using potential labor and physical capital resources fully to using them in a way that is not sustainable in the long term.
Thus, it is indeed possible for production to sprint above potential GDP, but only in the short run. So, in the short run, it is possible for producers to supply less or more GDP than potential if demand is too low or too high.
In the long run, however, producers are limited to producing at potential GDP. The Aggregate Demand Curve Aggregate demand, or AD, refers to the amount of total spending on domestic goods and services in an economy. Strictly speaking, AD is what economists call total planned expenditure.
Aggregate demand and aggregate supply
The quantity variable in the aggregate goods and services market is real GDP--the flow of goods and services produced and purchased during a period. The price variable in the goods and services market represents the average price of goods and services purchased during the period. In essence, it is the economy's price level, as measured by a general price index for example, the GDP deflator. Aggregate Demand Just as the concepts of demand and supply enhance our understanding of markets for specific goods, they also contribute to our understanding of a highly aggregated market such as that for goods and services.
The purchases of consumers, investors, governments, and foreigners comprise the nation's demand for goods and services. Thc aggregate demand curve indicates the various quantities of goods and services that purchasers are willing to buy at different price levels.
Alternatively, the quantity of goods and services purchased declines as the price level rises.
- Aggregate Supply (AS) Curve
- Section Review Questions/Answers
The explanation of the downward-sloping aggregate demand schedule differs from that for a specific commodity. The inverse relationship between price and the amount demanded of a specific commodity, TV sets, for example, reflects the fact that consumers turn to substitutes when a price increase makes a good more expensive. This relative price change will not be present when there is a change in the price of all goods. Instead, the inverse relationship between the price level and aggregate amount demanded reflects the impact of the fixed quantity of money.
As the level of prices declines, the purchasing power of the fixed quantity of money increases. Other people are in an identical position. As the price level declines, the purchasing power of their money balances also increases. This increase in wealth derived from the expansion in the purchasing power of the fixed money balances will induce people to purchase more goods and services as the price level declines.
In addition, a lower price level may also reduce the amount of money households and businesses want to hold in order to make purchases and conduct their affairs. The decline in the demand for money relative to the fixed supply of money will place downward pressure of interest rates.
This, too, will encourage people to purchase more goods and services.
Therefore, even though the explanation differs, the aggregate demand curve, like the demand curve for a specific product, slopes downward to the right. Aggregate Supply In view of the preceding discussion, it should come as no great surprise to the reader that the explanation for the general shape of the aggregate supply curve also differs from that for the supply curve of a specific good.
When considering aggregate supply, it is particularly important to distinguish between the short run and the long run. In this context, the short run is the time period during which some prices, particularly those in labor markets, are set by prior contracts and agreements. Therefore, in the short run, households and businesses are unable to adjust these prices in light of unexpected recent changes, including unexpected changes in the price level.
In contrast, the long run is a time period of sufficient duration that people have the opportunity to learn more fully about recent price changes and to modify their prior choices in response to them.
We now consider both the short-run and long-run aggregate supply curves Exhibit When that price level is achieved, firms will earn normal profits and supply output Y0. Why will an increase in the price level to P, for example enhance profitability, at least in the short run? Profit per unit equals price minus the producer's per unit costs.
Important components of producers' costs will be determined by long-term contracts.