In a short run free market capitalist economy the national income and employment is determined by the aggregate supply and aggregate demand. Aggregate supply means the total money value of goods and services produced in an economy in a year. There are two components of aggregate supply.
They are (i) the supply of consumer goods and services in a year, (ii) the supply of capital goods or investment goods as they help in producing further goods. Aggregate supply is the same thing as national product. The money value of national product of goods and services is distributed among the various factors of production as wage, rent interest and profits as rewards for the contribution of factors to the national product. The aggregate of wages, rent, interest and profit is called national income.
Factors determining aggregate supply:-
The supply of goods depends on the stock of capital, the amount of labour used and the state of technology. In the shot run stock of capital is constant and the output can be increased by increasing the amount of labour. Thus Y = (K.T.L) where Y is national output, T is the constant amount of technology and K is the constant amount of stock of capita! Given K and T, production of output is the increasing function of labour.
Production of output is done by given stock of capital and state of technology with employment of labour. However the amount of labour employed out of this given size of population can vary depending upon the demand for labour.
Aggregate Supply Curve:
There are two concepts of aggregate supply curve. First one is aggregate supply of output with the price level. The second erne is aggregate supply of output with national income. In order to simplify the analysis of determination of income and employment it is assumed that the nature of production function is such that average and marginal productivity of labour remains constant over relevant portion.
If money wage rate is fixed, then the average and marginal cost of output will not change as more output is produced and sold in the market. The supply of output will be expanded of the given price level in response to increase in aggregate demand. According to J.M. Keynes, more quantity of output will be produced and supplied at the same price before full employment of resources is reached no matter what the aggregate demand is.
In Keynesian model of determination of income and employment the aggregate supply not only depends’ on the stock of capital, population size, state of technology, average and marginal product of labour and money wages which are assumed to remain constant but also on the price level of output which is also held constant.
The aggregate supply curve is shown by 45° line. In the figure given below OZ is the supply curve. Along OX-axis is measured national income and along OY-axis is measured aggregate supply. All points on 45° line, have the same distance from OY and OX=axis. This means aggregate supply equals national income.
It shows the value of aggregate output increases at a constant rate. While drawing a supply curve, price level, wage arid productivity of labour and assumed to remain constant. If price level of money wage or productivity changes as level of aggregate. Production is ‘varied, the aggregate supply curve cannot be a”45° straight line throughout.
The aggregate supply curve shows varying levels of aggregate production or the supply of goods will be offered for sale at the given price-level. Up to the point of full employment of resources, any amount of output can be produced at the given price level depending an aggregate demand. The greater the aggregate demand, the greater the aggregate supply of output.