Aggregate supply

Keith Tan

The aggregate supply is the amount of output that all the domestic producers are willing to provide at various prices. 

We must distinguish between the very short, short, and long-run aggregate supply curves.

The main reason for the differences is due to the assumption regarding how input prices like wages, material costs and rent respond to changes in production levels.

In the very short run, it is assumed that the input prices remain fixed regardless of changes in production levels.  As such, companies can increase or decrease output to some degree without changing price, resulting in a perfectly elastic supply curve. Manufacturers can increase production in response to very short term spikes in orders by increasing overtime hours, maximising the existing plant and equipment, and by depleting its existing stockpile of components.  All these can be done without increasing the unit cost of each unit produced.

In the short run, the assumption is that only some input prices will change as production is increased or decreased, as some input prices can be slow to adjust.  This results in an upward sloping aggregate supply curve.  For example, the cost of certain components or raw materials may increase quickly due to the increased demand, but other input prices like wages may not have increased due to union contracts which can be valid for a few years.  Lease agreements can also be negotiated for a few years, so rental costs may not change in the short run.

In the long run, however, all input prices tend to “catch up” with the level of their demand. In other words, wages and other input prices that are slow to adjust in the short run adjust to changes in their demand the long run, resulting in a perfectly inelastic supply curve. 

Compare: Aggregate Demand

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