Aggregate supply

Last updated
Aggregate supply curve showing the three ranges: Keynesian, Intermediate, and Classical. In the Classical range, the economy is producing at full employment. Aggregate supply.svg
Aggregate supply curve showing the three ranges: Keynesian, Intermediate, and Classical. In the Classical range, the economy is producing at full employment.

In economics, aggregate supply (AS) or domestic final supply (DFS) is the total supply of goods and services that firms in a national economy plan on selling during a specific time period. It is the total amount of goods and services that firms are willing and able to sell at a given price level in an economy.[ citation needed ] Its natural counterpart is aggregate demand.



There are two main reasons why the amount of aggregate output supplied might rise as price level P rises, i.e., why the AS curve is upward sloping:

Different scopes

There are generally three alternative degrees of price-level responsiveness of aggregate supply. They are:

  1. Short-run aggregate supply (SRAS) — During the short-run, firms possess one fixed factor of production (usually capital), and some factor input prices are sticky. The quantity of aggregate output supplied is highly sensitive to the price level, as seen in the flat region of the curve in the above diagram.
  2. Long-run aggregate supply (LRAS) — Over the long run, only capital, labour, and technology affect the LRAS in the macroeconomic model because at this point everything in the economy is assumed to be used optimally. In most situations, the LRAS is viewed as static because it shifts the slowest of the three. The LRAS is shown as perfectly vertical, reflecting economists' belief that changes in aggregate demand (AD) have an only temporary change on the economy's total output.
  3. Medium run aggregate supply (MRAS) — As an interim between SRAS and LRAS, the MRAS form slopes upward and reflects when capital, as well as labor usage, can change. More specifically, medium run aggregate supply is like this for three theoretical reasons, namely the Sticky-Wage Theory, the Sticky-Price Theory and the Misperception Theory. The position of the MRAS curve is affected by capital, labour, technology, and wage rate.

In the standard aggregate supply-aggregate demand model, real output (Y) is plotted on the horizontal axis and the price level (P) on the vertical axis. The levels of output and the price level are determined by the intersection of the aggregate supply curve with the downward-sloping aggregate demand curve.


In the United Kingdom, aggregate supply data is published in the Office for National Statistics' Input–output supply and use tables. [1]

Policy interventions

Aggregate supply is targeted by government "supply-side policies", which are intended to increase productive efficiency and hence national output. Some examples of supply-side policies include education and training, research and development, supporting small/medium entreprise, reducing business taxes, undertaking labour market reforms to diminish frictions that may hold down output, and investment in infrastructure. For example, the United Kingdom's 2011 Autumn Statement incorporated a series of supply-side measures which the government was undertaking "to rebalance and strengthen the economy in the medium term", which included extensive infrastructure investment and development of a more educated workforce. [2] Supply-side reforms in the 2015 Budget addressed the nation's digital communications infrastructure, transport, energy and the environment. [3] In a speech to the G20 in February 2016, Mark Carney, Governor of the Bank of England, urged G20 members "to develop a coherent and urgent approach to supply-side policies". [4]

Continuing "supply-side reforms" were proposed by Liz Truss and Chancellor Kwasi Kwarteng as part of their 2022 economic programme, [5] [6] with reference to "a comprehensive package of supply-side reform and tax cuts" being made in the Growth Plan announced on 23 September 2022, [7] and further supply side growth measures promised for October and early November, including measures affecting the planning system, business regulation, childcare, immigration, agricultural productivity and digital infrastructure. [8] However, Larry Elliott in The Guardian has described this combination of reforms, reduced regulation and tax cuts as "one huge gamble". [9] The September Growth Plan commitments were mostly reversed by the Autumn Statement of 17 November 2022, although a limited number of initiatives relating to "supply side growth" were included in the latter statement. [10]

Within the UK government, HM Treasury's work on "the supply side" is led by the Enterprise and Growth Unit, [11] working in conjunction with other government departments and public bodies. [12] Sir John Kingman, a former civil servant who has been described as the "champion of HM Treasury's supply-side activism", [13] has referred to concern with "the supply side" as the "third mission" of the Treasury, [14] presenting former Chancellor of the Exchequer Nigel Lawson as a notable example of "those who believe in the importance of supply-side reform". [13]

"Supply-side pessimism" reflects a concern that productive capacity is lost when unused (e.g. during a recession), so that the economy loses the ability to recover aggregate supply when demand recovers. For example, unused factories are not kept in a state of readiness to be used when an economic upturn begins, or workers miss out on the skills and training which they would normally acquire whilst in work. [15] Spencer Dale, a British economist who sat on the Bank of England's Monetary Policy Committee between 2008 and 2014, took a pessimistic view of supply-side capabilities during the recession of 2012. [15] Cambridge economist Bill Martin reported on productivity pessimism in 2012, noting that there was an established debate about whether there had been a permanent loss of productive capacity, [16] which was reflected as a continuing level of "uncertainty ... related to the prospects for labour productivity and effective supply" as the economy recovered in 2013. [17]

See also

Related Research Articles

<span class="mw-page-title-main">Macroeconomics</span> Study of an economy as a whole

Macroeconomics is a branch of economics that deals with the performance, structure, behavior, and decision-making of an economy as a whole. This includes regional, national, and global economies. Macroeconomists study topics such as output/GDP and national income, unemployment, price indices and inflation, consumption, saving, investment, energy, international trade, and international finance.

In economics, stagflation or recession-inflation is a situation in which the inflation rate is high or increasing, the economic growth rate slows, and unemployment remains steadily high. It presents a dilemma for economic policy, since actions intended to lower inflation may exacerbate unemployment.

<span class="mw-page-title-main">Supply and demand</span> Economic model of price determination in a market

In microeconomics, supply and demand is an economic model of price determination in a market. It postulates that, holding all else equal, in a competitive market, the unit price for a particular good, or other traded item such as labor or liquid financial assets, will vary until it settles at a point where the quantity demanded will equal the quantity supplied, resulting in an economic equilibrium for price and quantity transacted. The concept of supply and demand forms the theoretical basis of modern economics.

<span class="mw-page-title-main">Inflation</span> Devaluation of currency over a period of time

In economics, inflation is a general increase of the prices of goods and services in an economy. This is usually measured using the consumer price index (CPI). When the general price level rises, each unit of currency buys fewer goods and services; consequently, inflation corresponds to a reduction in the purchasing power of money. The opposite of CPI inflation is deflation, a decrease in the general price level of goods and services. The common measure of inflation is the inflation rate, the annualized percentage change in a general price index. As prices faced by households do not all increase at the same rate, the consumer price index (CPI) is often used for this purpose.

<span class="mw-page-title-main">IS–LM model</span> Macroeconomic model relating interest rates and asset market

The IS–LM model, or Hicks–Hansen model, is a two-dimensional macroeconomic model which is used as a pedagogical tool in macroeconomic teaching. The IS–LM model shows the relationship between interest rates and output in the short run in a closed economy. The intersection of the "investment–saving" (IS) and "liquidity preference–money supply" (LM) curves illustrates a "general equilibrium" where supposed simultaneous equilibria occur in both the goods and the money markets. The IS–LM model shows the importance of various demand shocks on output and consequently offers an explanation of changes in national income in the short run when prices are fixed or sticky. Hence, the model can be used as a tool to suggest potential levels for appropriate stabilisation policies. It is also used as a building block for the demand side of the economy in more comprehensive models like the AD–AS model.

Full employment is a situation in which there is no cyclical or deficient-demand unemployment. Full employment does not entail the disappearance of all unemployment, as other kinds of unemployment, namely structural and frictional, may remain. For instance, workers who are "between jobs" for short periods of time as they search for better employment are not counted against full employment, as such unemployment is frictional rather than cyclical. An economy with full employment might also have unemployment or underemployment where part-time workers cannot find jobs appropriate to their skill level, as such unemployment is considered structural rather than cyclical. Full employment marks the point past which expansionary fiscal and/or monetary policy cannot reduce unemployment any further without causing inflation.

New Keynesian economics is a school of macroeconomics that strives to provide microeconomic foundations for Keynesian economics. It developed partly as a response to criticisms of Keynesian macroeconomics by adherents of new classical macroeconomics.

<span class="mw-page-title-main">Fiscal policy</span> Use of government revenue collection and expenditure to influence a countrys economy

In economics and political science, fiscal policy is the use of government revenue collection and expenditure to influence a country's economy. The use of government revenue expenditures to influence macroeconomic variables developed in reaction to the Great Depression of the 1930s, when the previous laissez-faire approach to economic management became unworkable. Fiscal policy is based on the theories of the British economist John Maynard Keynes, whose Keynesian economics theorised that government changes in the levels of taxation and government spending influence aggregate demand and the level of economic activity. Fiscal and monetary policy are the key strategies used by a country's government and central bank to advance its economic objectives. The combination of these policies enables these authorities to target inflation and to increase employment. In modern economies, inflation is conventionally considered "healthy" in the range of 2%–3%. Additionally, it is designed to try to keep GDP growth at 2%–3% percent and the unemployment rate near the natural unemployment rate of 4%–5%. This implies that fiscal policy is used to stabilise the economy over the course of the business cycle.

The Phillips curve is an economic model, named after Bill Phillips, that correlates reduced unemployment with increasing wages in an economy. While Phillips did not directly link employment and inflation, this was a trivial deduction from his statistical findings. Paul Samuelson and Robert Solow made the connection explicit and subsequently Milton Friedman and Edmund Phelps put the theoretical structure in place.

In macroeconomics, aggregate demand (AD) or domestic final demand (DFD) is the total demand for final goods and services in an economy at a given time. It is often called effective demand, though at other times this term is distinguished. This is the demand for the gross domestic product of a country. It specifies the amount of goods and services that will be purchased at all possible price levels. Consumer spending, investment, corporate and government expenditure, and net exports make up the aggregate demand.

A supply shock is an event that suddenly increases or decreases the supply of a commodity or service, or of commodities and services in general. This sudden change affects the equilibrium price of the good or service or the economy's general price level.

In economics, the long-run is a theoretical concept in which all markets are in equilibrium, and all prices and quantities have fully adjusted and are in equilibrium. The long-run contrasts with the short-run, in which there are some constraints and markets are not fully in equilibrium. More specifically, in microeconomics there are no fixed factors of production in the long-run, and there is enough time for adjustment so that there are no constraints preventing changing the output level by changing the capital stock or by entering or leaving an industry. This contrasts with the short-run, where some factors are variable and others are fixed, constraining entry or exit from an industry. In macroeconomics, the long-run is the period when the general price level, contractual wage rates, and expectations adjust fully to the state of the economy, in contrast to the short-run when these variables may not fully adjust.

Nobuo Okishio was a Japanese Marxian economist and emeritus professor of Kobe University. In 1979, he was elected President of the Japan Association of Economics and Econometrics, which is now called Japanese Economic Association.

The neoclassical synthesis (NCS), neoclassical–Keynesian synthesis, or just neo-Keynesianism was a neoclassical economics academic movement and paradigm in economics that worked towards reconciling the macroeconomic thought of John Maynard Keynes in his book The General Theory of Employment, Interest and Money (1936). It was formulated most notably by John Hicks (1937), Franco Modigliani (1944), and Paul Samuelson (1948), who dominated economics in the post-war period and formed the mainstream of macroeconomic thought in the 1950s, 60s, and 70s.

<span class="mw-page-title-main">AD–AS model</span> Macroeconomic model relating aggregate demand and supply

The AD–AS or aggregate demand–aggregate supply model is a macroeconomic model that explains price level and output through the relationship of aggregate demand (AD) and aggregate supply (AS).

<span class="mw-page-title-main">Demand-led growth</span>

Demand-led growth is the foundation of an economic theory claiming that an increase in aggregate demand will ultimately cause an increase in total output in the long run. This is based on a hypothetical sequence of events where an increase in demand will, in effect, stimulate an increase in supply. This stands in opposition to the common neo-classical theory that demand follows supply, and consequently, that supply determines growth in the long run.

<span class="mw-page-title-main">Factor market</span> In economics, a market where resources used in the production process are bought and sold

In economics, a factor market is a market where factors of production are bought and sold. Factor markets allocate factors of production, including land, labour and capital, and distribute income to the owners of productive resources, such as wages, rents, etc.

<span class="mw-page-title-main">History of macroeconomic thought</span>

Macroeconomic theory has its origins in the study of business cycles and monetary theory. In general, early theorists believed monetary factors could not affect real factors such as real output. John Maynard Keynes attacked some of these "classical" theories and produced a general theory that described the whole economy in terms of aggregates rather than individual, microeconomic parts. Attempting to explain unemployment and recessions, he noticed the tendency for people and businesses to hoard cash and avoid investment during a recession. He argued that this invalidated the assumptions of classical economists who thought that markets always clear, leaving no surplus of goods and no willing labor left idle.

The Fei–Ranis model of economic growth is a dualism model in developmental economics or welfare economics that has been developed by John C. H. Fei and Gustav Ranis and can be understood as an extension of the Lewis model. It is also known as the Surplus Labor model. It recognizes the presence of a dual economy comprising both the modern and the primitive sector and takes the economic situation of unemployment and underemployment of resources into account, unlike many other growth models that consider underdeveloped countries to be homogenous in nature. According to this theory, the primitive sector consists of the existing agricultural sector in the economy, and the modern sector is the rapidly emerging but small industrial sector. Both the sectors co-exist in the economy, wherein lies the crux of the development problem. Development can be brought about only by a complete shift in the focal point of progress from the agricultural to the industrial economy, such that there is augmentation of industrial output. This is done by transfer of labor from the agricultural sector to the industrial one, showing that underdeveloped countries do not suffer from constraints of labor supply. At the same time, growth in the agricultural sector must not be negligible and its output should be sufficient to support the whole economy with food and raw materials. Like in the Harrod–Domar model, saving and investment become the driving forces when it comes to economic development of underdeveloped countries.

This glossary of economics is a list of definitions of terms and concepts used in economics, its sub-disciplines, and related fields.


  1. Office for National Statistics, Input–output supply and use tables, last published 29 October 2021, accessed 4 October 2022
  2. H M Treasury, Autumn Statement 2011, November 2011, Annex A, pp. 53, 59
  3. H M Treasury, Budget 2015, published 18 March 2015, accessed 21 August 2022, pp. 94-100
  4. Mark Carney, Governor of the Bank of England, 'Redeeming an unforgiving world', G20 conference speech, February 2016, quoted in H M Treasury, Budget 2016, published 16 March 2016, accessed 21 August 2022, page 15
  5. Elliott, L., How is Liz Truss's government challenging 'Treasury orthodoxy'?, The Guardian, published 13 September 2022, accessed 14 September 2022
  6. HM Treasury, Chancellor Kwasi Kwarteng sets out economic priorities in first meeting with market leaders, updated 7 September 2022, accessed 14 September 2022
  7. UKOpenGovernmentLicence.svg  This article incorporates text published under the British Open Government Licence : HM Treasury, The Growth Plan 2022 , published 23 September, p. 9
  8. UKOpenGovernmentLicence.svg  This article incorporates text published under the British Open Government Licence : HM Treasury, Update on Growth Plan implementation , published 26 September 2022, accessed 8 October 2022
  9. Elliott, L., History suggests Kwarteng's gargantuan economic gamble won't end well, The Guardian, published 23 September 2022, accessed 26 September 2022
  10. HM Treasury, Autumn Statement 2022, sections 2.4, 5.70-5.75, published 17 November 2022, accessed 18 November 2022
  11. House of Commons Treasury Committee, Oral evidence: the work of the Treasury, HC 912, statement by Sir Tom Scholar, published 1 December 2021, accessed 21 September 2022
  12. HM Treasury Careers, Role of HM Treasury, accessed 23 September 2022
  13. 1 2 Ross, M., John Kingman, champion of HM Treasury's supply-side activism, warns of Brexit threat, Global Government Forum, published 24 October 2016, accessed 21 September 2022
  14. Kingman, J., The Treasury and the Supply Side, a lecture given for the Strand Group, an arm of the Policy Institute at King's College London, October 2016, accessed 21 September 2022
  15. 1 2 Jones, C., Cohen, N., Battle rages over supply shock risks to economy, Financial Times, 5 June 2012, accessed 26 August 2022
  16. Martin, B., Is the British economy supply constrained? A critique of productivity pessimism, published July 2011, accessed 26 August 2022
  17. Monetary Policy Committee of the Bank of England, Minutes of the meeting held on 31 July and 1 August 2013, published 14 August 2013, accessed 26 August 2022