By definition, the Aggregate Supply curve shows the relationship between the Aggregate Quantity Supplied by all the businesses and firms of an economy and the over price level.
The sum of the individual supply curve is not the aggregate supply curve. Why?
To know more details about the Aggregate Supply we need to understand how the firms operate in certain ways that make up changes in the overall economy.
- You should know that Aggregate Supply is not the amalgamation of the all the supply curves. The logic of Aggregate output associated with the overall price level is different than the individual supply and demand curves.
- Also, remember that the Aggregate Supply is not a market supply curve
What is the difference between Aggregate supply and market supply curve?
- A supply curve is the amount of quantity that every supplier is willing to produce at a given price level. And when we are drawing a supply curve, we assume that the input price and wages are constant. This also means that it shows only the change in output due to the change in price with no corresponding change in costs or other factors.
- Remember that individual firm’s output change wouldn’t really have an effect on the overall price of the economy.
- So what if the overall price level increase? We do agree that output of some firms is input to others. If output prices increase that will somehow be an increase in the input prices of other firms as well.
- We also agree that wage rates are never constant. Considering wage rate as an input price, this too will have an effect if there is an increase in the overall price level of the economy. This will shift the supply curve and we can incur that all the sum of these changes cannot come out with aggregate supply curve.
- Another point to support the notion that aggregate supply curve is not the sum of the individual supply curve is that most firms do not respond to prices changes in the market and they set their own prices for their products. Since realistically we don’t have perfectly competitive markets. Firms practically make decisions on the basis of their costs and demands. And we also know that price setting firms have no supply curves because these firms are adjusting their price and output at the same time. And since supply curves have no existence in imperfectly competitive markets, we cannot add up their sum to come up with Aggregate Supply curve.
Thus, sum of supply curves is not Aggregate Supply