Aggregate Supply: the total quantity of goods & services produced by all sellers at various prices, assuming that factor prices remain constaint.
This means, in the short term, wages and prices of raw materials and of other resources all also assumed to remain unchanged. This is not a totally unrealisitc
assumption. Most firms have little control over the market demand for their products, what they can do is control their own supply as much as they can as well as
their present and future costs. Firms can control costs by getting into contracts weith their suppliers and with their employees (or their unions) to achieve a little certainty
of future resource prices and wage rates. With these contracts, the firm is able to increase production (and demand, which will employ more factor services) without having to deal with an increase in the costs of those resources. With an increase in demand, firms can sell their products at a higher price which also results to wanting to produce more (employ more resources). Their total profits will be much higher as their costs still remain low.

The higer the price levels, the higher the aggregate quantity supplied will be; the lower the price level, the lower the aggregate quantity supplied will be.
The aggregate supply curve is upward-sloping and is very unlikely to be a straight line.

Determinants of aggregate supply
  • Improvement in human capital
  • increase in the amount of capital (natural resources)
  • improved technology
  • Quantity and Quality of Labour (Improved)

* If potential GDP increases, aggregate supply will also increase.

An increase in any of the determinants will shift the aggregate supply curve to the right which will equally shift potential GDP (economic growth). A decrease in any of the determinants will shift the aggregate suply curve to the left. (An increase in aggregate supply, leads to a higher real GDP but lower prices)

Neo-classical theory of aggregate supply:
Aggregate supply is vertical and equal to potential GDP. In the long run the economy is at full employment. The aggregate supply is the total value of all final goods and services when all resources are utilized. Neo-classical theory suggests that an increase in aggregate demand will lead to inflation. The only way to grow the economy is to increase natural resources, capital goods, technology and/or the quality or quantity of workers.
Keynesian theory of aggregate supply:
Aggregate supply is vertical. Big business and labour unions cause prices and wages to be inflexible/sticky. Changes in aggregate demand have little impact on inflation. Economic growth can be achieved by increasing aggregate demand- this happens by increasing government spending and investment spending.
Stephanie Powers, Solutions to Practice Final: Version A, (ECON 101 Winter 2012)
John E. Sayre. and Alan J. Morris, Principle of Macroeconomics, (U.S.A.: McGraw-Hill Ryerson Limited, 2009), 168, 178-179, 182-183 Graph is from slide 9 Of Stephanie Power Lecture Notes
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