This lesson introduces aggregate supply and explains how firms’ production decisions relate to the price level and potential GDP. Understanding these ideas helps explain why an economy may respond differently to changing demand depending on how much of its productive capacity is already in use.
Aggregate supply (AS) is the total quantity of output—real GDP—that firms are willing to produce and sell. The aggregate supply curve shows this quantity at each price level.
All flashcards
What is aggregate supply?
Aggregate supply is the total quantity of real GDP that firms are willing to produce and sell.
What is potential GDP?
Potential GDP is the sustainable level of real output an economy can produce by fully employing its existing labor, capital, and technology.
Why does the short-run AS curve slope upward?
When output prices rise while input costs are unchanged, firms can expect greater profits and are encouraged to increase production.
Why does AS become steeper near potential GDP?
As resources approach full use, labor and production capacity become harder to expand, so additional price increases generate smaller output increases.
Can output exceed potential GDP?
Yes, temporarily. Firms can use overtime and equipment intensively, but this level of production is not sustainable in the long run.
Quiz questions
What does aggregate demand measure?Answer: Planned spending on domestic goods and services at each price level.
How can a higher price level reduce spending through the interest rate effect?Answer: Greater demand for money and credit can raise interest rates and discourage borrowing.
If domestic prices rise relative to foreign prices, what tends to happen to net exports?Answer: Net exports tend to fall as exports decline and imports rise.
What does the intersection of aggregate demand and aggregate supply identify?Answer: Equilibrium real GDP and the equilibrium price level.
What does the vertical long-run aggregate supply curve represent?Answer: Long-run output at potential GDP, determined by productive capacity.
Based on Principles of Economics 3e by Steven A. Greenlaw, David Shapiro, Daniel MacDonald (OpenStax), licensed CC BY 4.0. Adapted into a summary, flashcards and quizzes.