Understanding Aggregate Supply & Demand

Understanding Aggregate Supply & Demand
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  • 0:01 Aggregate Supply & Demand
  • 0:40 Supply & Demand - Basics
  • 1:59 Aggregate Supply & Demand
  • 4:11 AS/AD Model
  • 5:33 Lesson Summary
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Lesson Transcript
Instructor: Christopher Sailus

Chris has an M.A. in history and taught university and high school history.

In this lesson, we explore aggregate supply and aggregate demand. In addition, we discover how economists represent these terms on a graph, using the AS/AD model.

Aggregate Supply and Demand

Sum totals can be important indicators for you in your daily accounting. For example, it's one thing to know you spent $4 on bacon yesterday, but it's much more helpful for budgeting purposes if you know you spent $72 on groceries all last week. That total can help you balance the rest of your budget and decide whether you need to spend less or more.

Totals are perhaps even more important on a larger, macroeconomic scale to help economists and decision makers decide what sectors of the economy are thriving and which are not. In this lesson we'll explore two such totals: aggregate demand and aggregate supply and the interplay between the two.

Supply and Demand - Basics

Before we talk about aggregate supply and aggregate demand, it's probably important for you to know what supply and demand are in the first place! Supply is the amount of goods the producers of a certain good are willing to provide to the marketplace. Demand is the amount of goods consumers are willing to buy of a certain good at a certain price. The two are usually represented together and are both directly affected by the price of a good. As the price of a good rises, its supply generally goes up, while its demand goes down. Conversely, if the price of a good falls, its supply usually falls, while its demand goes up.

This makes sense on the most basic level. For example, if I am selling apples for $1 apiece, and you have $3 in your apple budget, you will buy three apples. However, if you and three other people all want the same apples, I can charge more for those apples, say, $1.50. Now, you can only buy two apples this week. However, the same relationship works in reverse, too. If I get excited about how much I can charge for apples, and bring a supply of 20 apples to market and expect to charge $1.50, but you and those three other people can only buy 10 apples at $1.50, I have to lower the price of my apples in order to sell them all. This complex push and pull of supply and demand is what drives prices in local, national, and global marketplaces.

Aggregate Supply and Demand

While in our previous example we were talking about supply and demand as it pertains to individual markets and goods -- in that case, apples -- aggregate supply and demand refer to supply and demand across the entire marketplace! Aggregate supply refers to the total amount of goods supplied to the marketplace by all of the companies that participate in a given economy. This includes everything from apples to computers to car parts. Aggregate supply tries to estimate all of the products produced in an economy and help determine the overall strength and health of the economy in general.

Obviously, aggregate supply is very complicated; with thousands of different industries involved, the factors that change aggregate supply can be complex, and a final figure can be hard to determine. Generally, aggregate supply is broken up into four different parts: consumer goods, capital goods, public goods, and traded goods.

Consumer goods are things that you and I buy in the store every day, such as computers, food, or clothing. Capital goods are things which help industries create more consumer goods, like machinery. Public goods are goods and services which are provided to the government, usually by contractors. Finally, traded goods are any of the above goods which are created in one country and exported to another. Aggregate supply is affected by a range of factors, including the cost of making goods, the market price of goods, advances in technology, and the level of cash available in the marketplace.

On the other hand, aggregate demand is the total amount of goods and services that are bought given an average price level over the entire economy. This is an important distinction; in our earlier example we were talking just about the price of apples. If the demand for apples went down, it could be due to any number of factors: my prices being too high, people having less disposable income for apples, or people simply liking oranges better.

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