How Do Regular and Aggregate Supply and Demand Differ?

Simple or individual supply describes the amount of a good or service available to consumers from an individual producer. In economics, the law of supply and demand is one of the fundamentals of economic theory. It expresses a direct relationship between what producers supply and what consumers demand in an economy and how that relationship affects the price of a specific product or service.

Aggregate supply and aggregate demand are the total supply and total demand in an economy at a particular period and a particular price threshold. Both convey how much firms are willing to produce and how much consumers are willing to demand at a specific price point.

Key Takaways

• Aggregate supply is the total amount of goods and services produced by a company during a certain period at a specific price.
• Aggregate demand is the total expenditure of a company, which includes consumer consumption, investments, government spending, and net exports.
• Aggregate supply is affected by technology, labor market changes, and prices.
• Factors that affect aggregate demand include income, exchange rates, and inflation expectations.

Aggregate Supply

The term aggregate supply refers to the total quantity produced by all the companies supplying that product or service. It is also the total amount that companies plan to sell at a specific price during a certain period. Aggregate supply also represents an economy’s gross domestic product (GDP).

Several key factors can influence aggregate supply. They include:

• Technology
• Wage increases
• Change in the labor market
• Higher production costs

Inflation also has a major impact on aggregate supply. Rising prices mean that businesses should boost their production. When supplies remain constant as demand increases, consumers are willing to pay higher prices for available goods. This urges companies to increase their output. The resulting supply increase causes prices to normalize and output to remain elevated.

Important

Aggregate supply is calculated over 12 months. That’s because supply changes tend to lag compared to changes in demand.

Aggregate Demand

Aggregate demand represents the total demand for all goods and services produced in a nation’s economy. It is expressed as a dollar value—notably, the total amount of money a company spends on producing its goods and services at a certain price and time.

Aggregate demand includes the following components:

• Consumer consumption
• Investments
• Government spending
• Net exports

It is affected by several factors, including income and wealth, currency exchange rates, and inflation expectations.

Note

Aggregate demand is measured by market values, which means it only represents total output at a given price level. As such, it doesn’t represent a society’s standard of living.

Special Considerations

Increased supply generally occurs in response to a demand increase and results in lower prices over time. The amount of time required for businesses to respond to an increase in demand by increasing production varies significantly, depending on the product and industry.

If materials are difficult to obtain, the length of time required to bring additional products to market may increase in an economic model that is less responsive to demand changes. Price increases may result in reduced demand and cause too much supply.

Demand Curves

Aggregate supply and demand are represented separately by their curves. Aggregate supply is a response to increasing prices that drive firms to utilize more inputs to produce more output. The incentive is that if the price of inputs remains the same and the price of outputs increases, the firm will generate larger profits and margins by producing and selling more.

The aggregate supply curve slopes upward, indicating that as the price per unit goes up, a firm will supply more. The supply curve eventually becomes vertical, which means that a firm cannot produce anymore at a certain price point as it is limited by certain inputs, such as the number of employees and factories.

The aggregate demand curve is a downward-sloping curve. This indicates that when the price level increases, the total spending of an economy decreases. Consumption levels fall because people spend less as higher prices reduce their purchasing power.

As outputs rise, there is an increase in demand for money and credit to produce them, which leads to higher interest rates. Higher interest rates lead to lower investments. Furthermore, if prices in one nation go up, making their goods more expensive relative to other nations, that will reduce exports.

Why Is Supply and Demand Important?

The law of supply and demand helps producers determine the price of goods and services. As such, it helps producers decide output levels. The law also helps influence market dynamics and keeps the economy going.

What Are Some Limitations of Aggregate Demand?

There are several shortcomings related to aggregate demand. First, there is a focus on the quantity of goods and services produced—not the quality or the impact they can have on the quality of living. There may also be inequalities in purchasing power, as income isn’t necessarily evenly distributed in society. It may also be hard to determine why there are shifts in aggregate demand because of how economic factors are connected.

What Does the Law of Supply and Demand Say?

The law of supply and demand is an economic concept that tries to describe the relationship between buyers and sellers. According to the law, lower prices lead to a drop in supplies while higher prices often lead to higher supplies. Demand, on the other hand, increases when prices drop and lowers when prices increase.

The Bottom Line

The relationship between supply and demand can be expressed using an aggregate supply or aggregate demand curve. Using this economic law, businesses create better forecasts for future production needs to improve profitability. Pricing and marketing considerations are also directly impacted by supply and demand and represent another facet of this economic modeling.