Principles of Economics/ASAD

The Concept

The keystone concept of macroeconomics is the aggregation. In this sense, aggregate supply (AS) is the total of all goods supplied by the entire economy (of a nation, for example); it is not limited to any one industry. Likewise, aggregate demand (AD) is the total of all goods demanded by the entire economy; it too is not limited to any one industry. Oftentimes, the goods produced by one industry will become the goods demanded by another.

Aggregate Supply

There are generally three forms of aggregate supply (AS). They are:

1. Short run aggregate supply (SRAS) - Within the time frame during which firms can change the amount of labor used but not capital (such as building new factories). This form demonstrates what happens to the economy under the most slack, when resources are underused. Upward shifts in SRAS generally increase output (y) but don't increase price (P). The SRAS curve is nearly perfectly horizontal. The concept is that wages (price of labor) don't change over the short run.
2. Long run aggregate supply (LRAS) - Over the long run, only capital, labor, and technology affect the LRAS in the macroeconomic model because at this point everything in the economy is assumed to be used optimally. In most situations, the LRAS is viewed as static because it shifts the slowest of the three. The LRAS is shown as perfectly vertical, reflecting economists' belief that changes in aggregate demand (AD) have an only temporary change on the economy's total output.
3. Medium run aggregate supply (MRAS) - As an interim between SRAS and LRAS, the MRAS form slopes upward and reflects when capital as well as labor can change. When graphing an aggregate supply and demand model, the MRAS is generally graphed after aggregate demand (AD), SRAS, and LRAS have been graphed, and then placed so that the equilibria occur at the same point. The MRAS curve is affected by capital, labor, technology, and wage rate.

The Model

Fig - 1. The basic curves of the aggregate supply demand model.

The economy's output Y = q is the x axis; the price index P is the y axis. The Price index is generally defined as the overall cost of living; the most well-known price index is the Consumer Price Index (CPI). Aggregate demand (AD) is downward sloping; short-run aggregate supply (SRAS) is perfectly horizontal; medium-run aggregate supply (MRAS) is upward sloping; long-run aggregate supply (LRAS) is perfectly vertical.