Greetings, traders, and welcome back.
Thank you for joining me again.
My name is Chris, and I will be your host today during an
In-Depth with Chris episode.
Today, we're going to be covering the subject of aggregate supply.
And considering what's going on with this whole Covid-19
situation, and the global economies, and very tumultuous situations,
there's no better time than now to talk about this.
But without further ado, let's get going.
Aggregate supply: It's a scary word, yet it's the key driver of every economy.
We're going to talk about the aggregate supply definition,
as well as the supply curve, what shifts the aggregate supply,
aggregate supply in the long run, and even aggregate supply
in the short run, and at the end of all of this, we'll even do a quick review.
This is one of those subjects that is the information at the core of trading.
It's not a direct trading strategy per se, but this is the type of stuff
I see with the traders that have the skills to pass things like our Gauntlet Mini,
so please pay attention.
Aggregate what? Who? Aggregate supply refers to the total amount
of goods and services produced in an economy over a given
time frame and sold at a given price.
This even includes the supply of private consumer goods, public
and merit goods, capital goods, and even goods that are sold
overseas. For a more simplistic definition,
we can say that aggregate supply reflects the relationship
between the production value of the economy and price. When prices are rising,
typically, it means the businesses need to expand their production
and their supply to keep up with the aggregate demand.
If demand rises and supply remains constant, then the consumers
have to compete for all of the available goods, which in turn
raises the price. By increasing the production level to sell
more goods, the price then normalizes and equilibrium is finally
achieved. After aggregate supply comes the aggregate supply curve.
The aggregate supply curve shows a country's real
GDP that is supplied at different price levels.
This curve is based on the premise that, as price level increases,
producers can get more money for their products, which induces
them to produce even more.
However, this increase in price will also have a second effect;
An eventual increase in input prices, which is the cost
of production, with all things being equal, will cause the
producers to cut back on production.
Keep in mind that the premise for constructing the aggregate
supply curve is different from the premise used for constructing
supply curves for individual goods. The supply curve for an
individual good assumes that input price remains constant.
As the price of a product goes up,
the sellers' per-unit costs of providing the product don't
change. And so, they are willing to crank the supply even more.
This is why the supply curve for individual goods typically
has an upward slope. Since there is some uncertainty as to
whether a country's economy can supply more real GDP amid a rising price level,
it has become customary to differentiate between the two
types of aggregate supply curves. The two types include the
long-run aggregate supply curve and the short-run aggregate
supply curve. By distinguishing the two of them,
we have a more realistic overview of an economy's aggregate supply as a whole.
Now let's get "shifty". Anyone? No one? Alright.
There are many variables that can cause a shift
in aggregate supply. These include technological innovations,
changes in labor size and qualities, changes in production
costs, availability of resources, subsidies, changes in wages
and taxes, and the current inflation level.
All of these factors can lead to positive or negative shifts
in the aggregate supply curve.
There's a shift to the right when we have an increase in
labor efficiency, or a drop in the cost of production, lower
inflation levels, higher output, and easier access to raw materials,
things of that nature. Then, on the other hand, the aggregate
supply curve shifts to the left, as you can see right here,
following a rise in the production costs, or higher taxes
and wages, or reduced labor efficiency.
So, on the left-hand side right here, we have what happens when things become cheaper,
and on the right-hand side here, we have what happens when
things become more expensive to produce.
First, we'll cover the long-run aggregate supply curve.
The "long run" is a conceptual time period in which there are
no fixed factors of production.
Essentially, the period is expected to be long enough to allow
for wages, prices, and expectation adjustments, but not long
enough for physical capital to become a variable input. With
that in mind, we can then define the long-run aggregate supply,
known as the LRAS, as a concept that represents the optimum
output that can be produced by an economy when it utilizes
all of its factors of production and therefore operates at
full employment. In the long run, aggregate supply is not affected
by changes in the price level, and the curve only shifts based
on improvements in productivity and efficiency.
These improvements typically include enhanced skill levels,
newer advancements in technology,
and increases in capital. This essentially means that
price is inelastic in the LRAS model. One important thing
to note is that there are different economic views about
the long-run aggregate supply. For instance, on the left, we have the Keynesian
LRAS Theory, which asserts that long-run aggregate supply
only remains price-elastic up to a certain point. After this
point, supply essentially becomes uninfluenced by price changes.
In other words, there is a point in the economy where producers
of goods and services can expand their capacity.
However, once that point is reached, it wouldn't matter whether
price levels are rising or dropping. The long-run aggregate
supply by nature is a completely vertical curve.
You're probably wondering why? And that's just because the
GDP, the real GDP, in the long run, is dependent on the supply
of capital, labor, and raw materials as well as some other
factors outside of price. And as a result of this, the quantity
produced within that period remains the same regardless of
changes in the price level, which price is inelastic. This is
a stark difference from the supply curve for individual goods,
which are upward-sloping. In this case,
it's because the curve has to do with the prices of goods
in relation to other goods or services. Businesses can therefore
take advantage of relative prices to increase output.
As an example, let's say that we ran a distillery where we mass-produced
bourbon and gin. If the price of bourbon rises, we can focus
our resources on distilling more bourbon to take advantage
of the price rise, hence the relative price influence on supply. With aggregate supply
however, the entire economy's production would be limited
by the availability of land, labor, capital, and other resources.
It won't matter whether the price levels increase or decrease.
The overall output cannot go past the point allowed by the country's available
resources. As we can see with our graphs, we can see how the
LRAS curve captures the relation between price level, aggregate
demand, and the production flow over a given period of time.
In the classic view, even as price rises, the LRAS remains
vertical. Under the Keynesian view,
the LRAS curve itself is elastic up into a certain point
before it becomes vertical and insensitive to price.
Then, we have the short-run aggregate supply curve.
The short-run aggregate supply refers to the total production
of goods and services available in an economy at different
price levels, while some production factors and resources
are fixed, with fixed being the key word here.
This just means that even if the companies increase their
supply due to rising prices by hiring more workers or extending
work hours, certain capital- intensive resources are pretty
much impossible to achieve in the short run.
These capital-intensive resources include things like office
space, new machinery, and extra skilled manpower.
There's no specific unit of time associated with the short-run
period, so it may be two months, eight months, or even a
year. Instead of a fixed time period, it is tied to the duration
for which those resources are fixed. How quickly can the company
set up a new factory or warehouse?
How long will it take to obtain a loan to purchase and install
a new machine? Or, how quickly
can employees be trained to expand their skills?
The answer to these questions is what determines the length of the short run.
The presumption underlying the SRAS curve, which is the short-run
aggregate supply curve, is that providers of resources
required for production do not immediately respond to the increase in price level.
For instance, in the distillery example that we were talking
about, if there was a general increase in price level for
whiskey and gin across the globe, the distillery may expand
production right away. However, the malt and barley farmers, on the other hand, may
not increase their own prices right away.
It might take some time. With this chart here,
we can see exactly what an SRAS curve looks like.
Once again, that is the short-run aggregate supply.
It shows the direct relationship between the changes in price
level and the output quantity in the short run. The higher
the price, the more output supplied and vice versa.
You have survived the aggregate supply, but almost. Before we go,
let's make sure we remember what we have discussed.
Why does the short-run aggregate supply curve slope upwards?
Well, the answer is the short-run aggregate supply curve
slopes upwards because it has a direct relationship with
the changes in the price level in the short run. The higher
the price, the higher the output. This relationship is then
drawn on an upward slope.
Now question number two: Why is the long- run aggregate supply curve vertical?
Well, the long-run aggregate supply we know as the LRAS
is vertical because in the long run, changes in price do not
affect the total output. Total output is instead influenced
by other factors of production, such as labor, resources, and capital.
Question number three: What relationship does the aggregate supply curve describe?
Think about it. Alright.
The aggregate supply curve describes the relationship
between real GDP and changes in price levels.
This is broken down into two main aggregate supply curves
like we covered. The short-run and the long-run.
These are called the short-run aggregate supply and long-run
aggregate supply curves, otherwise known as the SRAS
and the LRAS. And finally, what is the effect of an increase in the price
level on the short-run aggregate supply curve? Think about it.
Okay. An increase in price level in the short-run aggregate
supply, the SRAS, means a resulting increase in the total
output as companies look to profit from higher prices.
This goes back to the notion that the short-run aggregate
supply curve is upward-sloping. The higher the price, the higher
the output due to the company's desire for profit.
Congratulations everyone and cheers, you did it!
And don't worry, it's just kombucha. You figured out what the aggregate supply
is, in both the long-run variation as well as the short-run
variation, and you made it through to the end. If you
think you have what it takes to take your trading knowledge
to the next level, make sure you check out our Gauntlet Mini
and see if you have what it takes to pass.
If you do, you could become a funded trader. But other than
that, thank you for joining me yet again everybody,
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