Definition: Aggregate supply is the total value of goods and services produced in an economy over a given period of time.
Short Run Aggregate Supply (SRAS)
SRAS slopes upwards because as prices increase, it becomes more profitable for firms to increase their output and new firms start producing.
Reasons why Short Run Aggregate Supply shifts:
- Changes in resource prices (labor, raw materials, etc.)
- Changes in business (corporate) taxes and subsidies
- Supply shocks
Long Run Aggregate Supply (LRAS)
LRAS is vertical because the economy is at its full capacity. It is impossible to increase production in response to growing aggregate demand.
Monetarist/New Classical view: LRAS is vertical at full employment level of output at full capacity and potential output. Potential output is based on factors of production quantity and quality, hence the price level does not affect the Long Run Aggregate Supply.
Keynesian view: an economy has 3 different sections on the AS curve:
- 0 to Y1 – enough spare capacity in the economy to increase production without increasing costs.
- Y1 to Y2 – also known as the “bottleneck” – the economy is approaching full capacity, hence costs for hiring the scarce resources begin to rise.
- Y2 – the economy is at full employment (in LR at full capacity), therefore attempts to increase production will only cause price level to rise.
Reasons why Long Run Aggregate Supply shifts:
- Changes in the stock of resources (labor, land, etc.)
- Changes in technology
- Changes in quality of factors of production (leading to improvements in efficiency/productivity)
- Institutional changes