Commerce Exam > Commerce Notes > Aggregate Demant supply
Aggregate Demant supply - Commerce PDF Download
| Table of contents |
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| Key points |
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| Introduction |
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| The aggregate supply curve |
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| Potential GDP |
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why investment is constant in AD schedule
Ref: https://edurev.in/question/769046/why-investment-is-constant-in-AD-schedule-Related-Point-of-aggregate-demand-curve-in-detail-Economi
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Key points
- Aggregate supply is the total quantity of output firms will produce and sell—in other words, the real GDP.
- The upward-sloping aggregate supply curve—also known as the short run aggregate supply curve—shows the positive relationship between price level and real GDP in the short run.
- The aggregate supply curve slopes up because when the price level for outputs increases while the price level of inputs remains fixed, the opportunity for additional profits encourages more production.
- Potential GDP, or full-employment GDP, is the maximum quantity that an economy can produce given full employment of its existing levels of labor, physical capital, technology, and institutions.
- Aggregate demand is the amount of total spending on domestic goods and services in an economy.
- The downward-sloping aggregate demand curve shows the relationship between the price level for outputs and the quantity of total spending in the economy.
Introduction
To understand and use a macroeconomic model, we first need to understand how the average price of all goods and services produced in an economy affects the total quantity of output and the total amount of spending on goods and services in that economy.
The aggregate supply curve
Firms make decisions about what quantity to supply based on the profits they expect to earn. Profits, in turn, are also determined by the price of the outputs the firm sells and by the price of the inputs—like labor or raw materials—the firm needs to buy. Aggregate supply, or AS, refers to the total quantity of output—in other words, real GDP—firms will produce and sell. The aggregate supply curve shows the total quantity of output—real GDP—that firms will produce and sell at each price level.
The graph below shows an aggregate supply curve. Let's begin by walking through the elements of the diagram one at a time: the horizontal and vertical axes, the aggregate supply curve itself, and the meaning of the potential GDP vertical line.
The aggregate supply curve. Image credit: Figure 1 in "Building a Model of Aggregate Demand and Aggregate Supply" by OpenStaxCollege, CC BY 4.0
The horizontal axis of the diagram shows real GDP—that is, the level of GDP adjusted for inflation. The vertical axis shows the price level. 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?
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.
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Nov 25, 2024 Last updated |
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