Aggregate Supply

<Last updated 12.04.2020>

Dear reader,

Hi! If you are interested in Economics, I’ve prepared the below to help your understanding. You should take a look at this short article in which I explain how Supply for goods and services is formed and how Prices are determined by Demand and Supply .

We have seen that Aggregate, or Total Demand, is formed by people’s preferences. A negative relationship exists between price and quantity demanded.

Aggregate Supply: The relationship between price and quantity supplied, at each price level the quantity supplied is different (specified for a specific period). The quantities supplied must be from suppliers that have the desire and can (afford to) provide.

As the price increases, this means that businesses can make more profit by producing and supplying more products to increase revenue. This is from where the Law of Supply is derived: With other factors affecting quantity supplied equal (ceteris paribus), there is a positive relationship between price and quantity supplied. This means that when price increases, quantity supplied is more. (From Qo to Q1).

Adding up all businesses/providers supply curves: It is important to note here that each business entity, or supplier, has a different curve, meaning that each response is different to price increases. For example, Andreas LTD company wants to provide more quantities when there is a price increase from 3 to 4 . However, George LTD wants to provide also more due to the same price level increase, but less quantity than Andreas LTD wants to provide. These business “preferences” are determined by factors such as production/provision cost.

> We add up all quantities supplied at each specific price level to find the Total/Aggregate Supply curve (line in this case).

When the price increases, suppliers want to provide higher quantities of goods. Suppliers find opportunities to generate profit by providing more. Suppliers increase production and provision of the good in concern, and new suppliers enter the market to supply as well. Total production/provision of the good increases.

What makes businesses to supply more or less quantities of goods if price is not the cause? The most important factors affecting Supply are:

a) Prices of Factors of Production: The cost of producing goods and services. When price of a factor of production falls this reduces the cost of production/provision.

b) Technology: A technological improvement, an improvement in the way factors of production are used in the production process (i.e. Machinery, PCs etc that save time and increase productivity) increase productivity of capital and labor, reducing the cost per unit of output, leading to increase in production/provision of goods and services.

c) Supplier Expectations: Expectations regarding the future market conditions of the good in concern affect supplier’s decisions today. Expecting that the price of the good will be increased in the future, reduces its supply today (maybe stored in inventory). This leads to decrease in production/provision today. Expectations concern also the future prices of factors of production, technology etc.

d) Prices of Other Goods:  –Alternative Goods: the goods that can be produced using the same resources. Shifts in production of other goods happens due to price increase, reducing profits from lower demand of the currently produced good.

e) Number of suppliers: More suppliers means more total production/provision.

f) Weather Conditions: weather conditions affect production of goods and services. This can be easily experienced in agriculture, where weather conditions affect production in critical levels. (no rain, too much heat, storms etc.).

All the previous factors cause a shift. We have a shift of the Supply curve (line in this case):

Some Factors shifting supply for a good to the right (increase):

> Decrease in the price of Factors of Production (lower cost).

> Increase in consumer Income.

> Better weather conditions.

> Lower expected future price of the good.

Equilibrium exists when the price balances Supply and Demand, a level where no entity, buyer or seller, wants to deviate from that level. The following graph shows Supply with Demand, how these two forces together determine the price level and how they can affect it:

The equilibrium price is the price at which quantity demanded equals quantity supplied. At EP.

“I hope I am clear on this one. If not, contact us on social media and we will do our best to help you.

Thank you for reading my articles and watching my videos.”

Marios Kyriakou