Aggregate Supply (AS)

Definition= Is the total real output firms are willing to supply at each price level.

Short-run AS (SRAS):

In the short-run (i.e. period of fixed input prices) the SRAS curve will slope upwards. The SRAS curve can sometimes be drawn curving upwards, being considerably steeper as the economy approaches full employment output.

Profit= revenue-cost of production

A change in the price level causes a movement along the SRAS curve but a change in any other determinant will cause the SRAS to shift.

Determinants of SRAS include:

1. Capital (stock)= determined by past capital stock, depreciation and investment.
2. Labour supply= determined by working age population, activity rates, average hours worked and quality of labour
3. Land (Natural resources)
4. Technology
5. Input prices including Import prices (Short-term)
6. Indirect taxes including VAT which raise firm's costs (Short-term)

Any change which increases firm's costs, hence lowering profits, will shift the SRAS curve left. Similarly any change which lowers costs, boosting profits, will shift the SRAS curve right.

Aggregate Demand (AD)

Definition= Is the total level of planned spending in an economy over a given time period.

The Aggregate demand curve:

i.e a curve relating price level to total spending in the economy

The AD curve slopes downwards as:

1. As price level falls international competitiveness rises therefore imports (a withdrawal) fall and exports (an injection) rise therefore AD rises.
2. As price level falls real incomes and real wealth rise therefore consumption rises.

NOTE: A change in the price level will move the economy along the AD curve whereas a change in any other determinant will cause a shift in the AD curve.

Inflation= average/general increase in prices

Real inflation= adjusted inflation

Determinants of AD include:

1. Investment (I)
2. Consumption (C)
3. Government Spending (G)
4. Exports (X)
5. Imports (M)

AD= C + I + G + X - M