Aggregate Supply And Demand

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While reviewing the aggregate level of supply and demand, many of the same principles of basic supply and demand apply to this cycle. Aggregate supply is defined as “a schedule or curve showing the relationship between a nation’s price level and the amount of real domestic output that firms in the economy produce” while aggregate demand is “a schedule or curve that shows the various amounts of real domestic output that domestic and foreign buyers desire to purchase at each possible price level.” It has an inverse relationship, due to the Real Balances Effect, the Interest Rate Effect, and the Foreign Purchases Effect. Aggregate supply schedules can be categorized in three ways based on the flexibility of the input and output prices. In the immediate short run, both the input and output prices are fixed. This period can last anywhere from a few days to a few months. Since 75% of the firm’s costs are wages and salaries, fixed labor contracts are almost always involved. Setting prices …show more content…
The determinants of aggregate supply are: changes in input prices (domestic/imported resource prices), changes in productivity, and changes in legal-institutional environment (business taxes and subsidies, government regulations). Decreasing the aggregate supply will cause a shock to the short-term market and result in a leftward shift, an increase in price level, and a decrease in real production. An example is a depletion of existing mineral deposits causing a shortage of material to produce an item, thus decreasing supply and raising the price level for that product, as it is in high demand. Increasing aggregate supply will cause a shock to the short-run market and result in a rightward shift of the curve, a decrease in the price level, and an increase in real production. An example is an increase in technology would allow companies to produce more goods at a higher efficiency

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