Short Run Aggregate Supply (SRAS)

This is an updated revision presentation covering some of the factors that determine short run aggregate supply (SRAS) in an economy.

1. Short Run Aggregate Supply AS Economics, Autumn 2013

2. Short Run Aggregate Supply (SRAS) Aggregate supply (AS) is the quantity of goods and services that businesses are willing and able to produce at a given level of prices SRAS is the relationship between real GDP and the price level SRAS shows how much output the economy can generate in the short term at each price level A rise in the price level should stimulate an expansion of supply When prices are falling, production may contract

3. Short Run Aggregate Supply (SRAS) We hold the following constant: Wage rates for labour Other resource prices such as raw material prices and component prices Changes in aggregate demand cause either a contraction or an expansion along the SRAS curve An outward shift of AD will cause an expansion along the SRAS curve An inward shift of AD will cause a contraction along the SRAS curve

4. Short Run Aggregate Supply Curve Real National Output Price Level SRAS1 P1 Y1 P2 Y2

5. Short Run Aggregate Supply Curve Real National Output Price Level SRAS1 P1 Y1 P2 Y2

6. AD1 Short Run Aggregate Supply Curve Real National Output Price Level SRAS1 P1 Y1 P2 Y2 A rise in the price level will cause an expansion of aggregate supply in the economy Producers are responding to higher prices (driven up by increased demand) Real national output will increase from Y1 to Y2 AD2

7. Some Causes of Shifts in Short Run Aggregate Supply (SRAS)

8. Shifts in short run aggregate supply Costs of production Wage costs Minimum wages Impact of migration of workers on labour costs Raw material and component prices (inputs into production) Taxes that businesses have to pay VAT Import tariffs and other protectionist measures Environmental taxes / charges such as climate change levies Labour productivity Factor mobility and economic incentives facing workers and firms Changes in the exchange rate – which affects the price of imported components Many SRAS shifts are caused by external economic shocks

9. External supply shocks

10. Inward Shift in SRAS Price Level SRAS1 Y2 P1 Y1 SRAS2 RNO Inward shift of SRAS Less output can be supplied at each price level

11. Outward Shift in SRAS Price Level SRAS1 Y2 P1 Y1 SRAS2 RNO SRAS3 Y3 Outward shift of SRAS More output can be supplied at each price level

12. Crude oil prices affect production costs The UK is now a net importer of oil – it is an input used in many different industries

13. How might wheat prices affect SRAS? Which industries / sectors use wheat as a key factor input?

14. Steel prices will also affect SRAS Falling steel prices would reduce supply costs in the construction industry causing SRAS to shift outwards

15. International commodity prices Commodity prices have been highly volatile in recent years

16. The Keynesian non-linear SRAS curve Price Level RNO P2 P1 SRAS AD1 AD2 Between Y1 and Y2, short run aggregate supply is elastic – because there is plenty of spare capacity in the economy Y1 Y2

17. The Output Gap and the Economic Cycle When an economy is coming out of recession, the output gap is negative and SRAS is likely to be elastic because of spare capacity

18. When SRAS is vertical, capacity is reached Price Level RNO LRAS Yfc SRAS AD3 In this equilibrium at AD3, Y3 – SRAS is drawn as inelastic – where bottlenecks in the supply chain make it difficult to supply extra output when there is an increase in AD Y3 P3

19. When SRAS is vertical, capacity is reached Price Level RNO LRAS Yfc SRAS AD3 Y3 AD4 P3 P4

20. When SRAS is vertical, capacity is reached Price Level RNO LRAS Yfc SRAS AD3 Y3 AD4 P3 P4 When SRAS is inelastic, an increase in AD will tend to cause a larger rise in the price level and relatively little extra real output (Y)

21. Capacity Pressures in the UK Economy At the tail end of a boom, shortages of skilled workers and key raw materials and components can cause a capacity constraint – making SRAS inelastic

22. The Keynesian non-linear SRAS curve Price Level RNO P2 P3 P4 P1 SRAS AD1 AD2 AD3 AD4

23. Non-linear SRAS curve When the economy has plenty of spare capacity – SRAS will be elastic Rise in AD can be met easily by increased output Little threat of rising prices (inflation) Elasticity of SRAS curve falls as output increases Spare capacity falls Possibility of diminishing returns in production Bottlenecks in supply of inputs and components When SRAS becomes perfectly inelastic the economy has reached full capacity Further increases in AD at this point are purely inflationary.

24. Inward shift of short run aggregate supply Price Level Real National Output (Y) P1 SRAS1 AD1 SRAS2 Y1 Y2 P2

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