Definition: In traditional economics, aggregate supply refers to the total factor productivity of the economy. Aggregate supply is a key macroeconomic variable because it affects the overall level of prices paid by consumers. When aggregate demand increases, prices tend to fall. As a consumer, one need to be aware of how your income is changing and the overall level of aggregate demand. When aggregate supply exceeds aggregate demand, prices tend to rise.
The aggregate supply can be identified by measuring its price and adjusting for changes in investment, production technology, and alternatives. There are different ways in which an aggregate supply can be defined. For example, in the case of an output good, such as a barrel of oil, the price is the purchase price plus output costs. In the case of a service or input good, like a plumber’s repair bill, the price reflects the opportunity cost of replacing the material used in the construction.
Aggregate supply is the total number of goods and services produced in a year, regardless of type. It changes over time because the supply of goods and services depends on many factors, including what people want, how efficient they are at producing goods and services, what is available in the marketplace, etc. When aggregate supply proliferates, it can lead to booms and busts in the economy with disturbances in investment spending, industrial production, and employment. People react to these disturbances by changing their purchases of goods and services.
Short-term changes in aggregate supply ripple through the economy and affect consumption and investment in many different ways. Changes ripple fastest through industries where changes have already occurred, such as when new mines or factories open, new equipment and infrastructure are built, or when existing factories are converted to make products using less energy and resources.
Long-term changes in aggregate supply are impacted due to innovations in the essential materials used in manufacturing (such as 3D printing), new tools and techniques (such as robotic welding), new regulations affecting the industry (such as fuel economy standards), or simply shifts in consumer behavior due to new technology available.
The aggregate supply curve (also called the production function, or simply the supply curve) describes how quickly a specific good or service supply is created. It is typically influenced by technological changes and innovations that affect how goods and services are produced and how we buy them. In the early years of the internet, aggregate demand was dominated by mass-market products such as newspapers and books – but as information and communication technology advanced, aggregates became more specialized. As a result, aggregate supply curves are often thin, with rapid increases emerging only after minimal effort (and legal barriers to entry have been removed).
Aggregate supply is directly related to market prices. When aggregate supply rises due to an increase in efficiency, it leads to lower prices because consumers have more choices. Conversely, when aggregate supply falls due to increased efficiency, it leads to higher prices because fewer resources are available for use. This effect is strongest for inputs that are labor-intensive and capital-intensive such as machinery and plant building.