Aggregate supply is the total goods and services that producers are willing and able to supply (produce) at a given price level.
Understanding aggregate supply is necessary for comprehending the relationship between inflation, employment, and gross domestic product (GDP). The aggregate supply curve is a graph showing the relationship between an economy’s real gross domestic product (RGDP) and its price level.
Short-Run Aggregate Supply Curve
Higher price levels caused by a growing aggregate demand drive companies to increase production to meet the growing demand, before the capital structure is measurably changed. Short-run changes are difficult because it takes time for companies to increase their capacity with new plants or equipment. Instead, manufacturers respond to the rising aggregate demand by increasing the utilization of their existing factors of production by requiring employees to work longer hours or adding a shift at the plant.
The short-run aggregate supply curve is influenced by the timing of changing prices on the macroeconomic level. In the short-run, the prices of the factors of production and the final goods and services change at different rates. These discrepancies provide opportunities for businesses. Profits rise when the price of the final good or service increases more (on a percentage basis) than the cost to provide the good or service. When this happens companies increase production. Profits drop when the input prices increase at a faster rate than the price of the good or service. In these cases, suppliers are willing to furnish less. The positive slope of the short-run aggregate supply curve is explained by the different timing of price changes in the factors of production market.
Graph 1 is a short-run aggregate supply curve (SRAS). The economy's price-level is on the vertical axis, and its output measured in RGDP is on the horizontal axis. It slopes upward because as the price-level increases, producers would take advantage of the short-run price increase and boost production.
Long-Run Aggregate Supply
An economy's potential production is limited by the resources available, or its factors of production. Economists assume that all prices and costs eventually increase at the same rate to the same price-level. In other words, a change in the price-level will have no impact on production in the long-run, resulting in a vertical long-run aggregate supply curve. Instead, permanent changes derived from improved technology or a larger or better educated work force increase the long-run aggregate supply curve.
The economy's long-run aggregate supply curve has been added in Graph 2. P is the price-level where the long-run and short-run aggregate supply is in equilibrium.
Here's a short video that explains Aggregate Supply in more detail: