Aggregate Supply

Introduction Definitions and Basics

●      Aggregate Supply, at

●      The total supply of goods and services produced within an economy at a given overall price level in a given time period. It is represented by the aggregate-supply curve, which describes the relationship between price levels and the quantity of output that firms are willing to provide. Normally, there is a positive relationship between aggregate supply and the price level. Rising prices are usually signals for businesses to expand production to meet a higher level of aggregate demand.

●      New Classical Macroeconomics, from the Concise Encyclopedia of Economics

●      Shocks to aggregate supply are typically changes in productivity that may result, for example, from transient changes to technology, prices of raw materials, or the organization of production. Ideally, firms would choose to produce more and to pay their workers more when the economy has been hit by favorable shocks and less when hit by unfavorable shocks. Similarly, workers would be willing to work more when productivity and wage rates are higher and to take more leisure when their rewards are lower. For both, the rule is “make hay while the sun shines.”…

●      National Income Accounts, from the Concise Encyclopedia of Economics

●      The broadest and most widely used measure of national income is gross domestic product (GDP), the value of expenditures on final goods and services at market prices produced by domestic factors of production (labor, capital, materials) during the year. It is also the market value of these domestic-based factors (adjusted for indirect business taxes and subsidies) entering into production of final goods and services. “Gross” implies that no deduction for the reduction in the stock of plant and equipment due to wear and tear has been applied to the measurements and survey-based estimates. “Domestic” means that the GDP includes only production by factors located in the country–whether home or foreign owned. GDP includes the production and income of foreigners and foreign-owned property in the home country and excludes the production and incomes of the country’s own citizens or their property located abroad….

In the News and Examples

●      OPEC, from the Concise Encyclopedia of Economics

●      Despite what many noneconomists believe, the 1973-1974 price increase was not caused by the oil “embargo” (refusal to sell) that the Arab members of OPEC directed at the United States and the Netherlands. Instead, OPEC reduced its production of crude oil, raising world market prices sharply. The embargo against the United States and the Netherlands had no effect whatsoever: people in both nations were able to obtain oil at the same prices as people in all other nations. This failure of the embargo was predictable, in that oil is a “fungible” commodity that can be resold among buyers….

●      Inflation, from the Concise Encyclopedia of Economics

●      Some economists call the above analysis a “demand-pull” explanation (monetary expansion fuels spending that pulls prices up), while proposing a “cost-push” alternative. For particular episodes of inflation, they have variously blamed monopolies, labor unions, OPEC, and even the failure of the anchovy harvest off Peru for pushing up prices. The equation of exchange warns us that for a “supply shock” to account for a large rise in the general price level (not just a relative rise in some prices, such as the price of oil), the economy’s output must shrink by a large percentage. In practice, “supply shock” cases are seldom large enough to account for much inflation and are typically short-lived….

A Little History: Primary Sources and References

●      Jean-Baptiste Say, biography from the Concise Encyclopedia of Economics

●      Say’s Law has various interpretations. The long-run version is that there cannot be overproduction of goods in general for a very long time because those who produce the goods, by their act of producing, produce the purchasing power to buy other goods. Say wrote: “How could it be possible that there should now be bought and sold in France five or six times as many commodities as in the miserable reign of Charles VI?” With this statement Say had the long run in mind. Certainly the long-run version is correct. Given enough time, supply does create its own demand. There can be no long-run glut of goods.

●      But Say also had a short-run version, that even in the short run there could be no overproduction of goods relative to demand. It was this version that Malthus attacked in the nineteenth century and that Keynes attacked in the twentieth century. They were right to attack it….

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