Aggregate Supply - Analysis

Analysis

There are two main reasons why Qs might rise as P rises, i.e., why the AS curve is upward sloping:

• aggregate supply is usually inadequate to supply ample opportunity. Usually this is fixed capital equipment. The AS curve is drawn given some nominal variable, such as the nominal wage rate. In the short run, the nominal wage rate is taken as fixed. Thus, rising P implies higher profits that justify expansion of output. In the neoclassical long run, on the other hand, the nominal wage rate varies with economic conditions. (High unemployment leads to falling nominal wages -- and vice-versa.)
• An alternative model starts with the notion that any economy involves a large number of heterogeneous types of inputs, including both fixed capital equipment and labor. Both main types of inputs can be unemployed. The upward-sloping AS curve arises because (1) some nominal input prices are fixed in the short run (as in the neoclassical theory) and (2) as output rises, more and more production processes encounter bottlenecks. At low levels of demand, there are large numbers of production processes that do not use their fixed capital equipment fully. Thus, production can be increased without much in the way of diminishing returns and the average price level need not rise much (if at all) to justify increased production. The AS curve is flat. On the other hand, when demand is high, few production processes have unemployed fixed inputs. Thus, bottlenecks are general. Any increase in demand and production induces increases in prices. Thus, the AS curve is steep or vertical.

AS is targeted by government "supply side policies" which are meant to increase productivity efficiency and national output. For example, education and training and research and development.