AS Economics

tutor2u™

Short Run Aggregate SupplyAS Economics, Autumn 2013

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

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

Short Run Aggregate Supply Curve

Real National Output

Price Level SRAS1

P1

Y1

P2

Y2

Short Run Aggregate Supply Curve

Real National Output

Price Level SRAS1

P1

Y1

P2

Y2

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

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

Labour productivity

Prices of raw materials

Price of componentsWage Costs

Changes in import prices

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

External supply shocks

World oil and gas prices

Energy prices / costs

Other mineral prices

Foodstuff prices

Import tariffs / quotas

Inward Shift in SRAS

Price LevelSRAS1

Y2

P1

Y1

SRAS2

RNO

Inward shift of SRAS

Less output can be supplied at each price

level

Outward Shift in SRAS

Price LevelSRAS1

Y2

P1

Y1

SRAS2

RNO

SRAS3

Y3

Outward shift of SRAS

More output can be supplied at

each price level

Crude oil prices affect production costs

The UK is now a net importer of oil – it is an input used in many different industries

How might wheat prices affect SRAS?

Which industries / sectors use wheat as a key factor input?

Steel prices will also affect SRAS

Falling steel prices would reduce supply costs in the construction industry causing SRAS to shift outwards

International commodity prices

Commodity prices have been highly volatile in recent years

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

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

When SRAS is vertical, capacity is reached

Price Level

RNO

LRAS

Yfc

SRASAD3

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

When SRAS is vertical, capacity is reached

Price Level

RNO

LRAS

Yfc

SRASAD3

Y3

AD4P3

P4

When SRAS is vertical, capacity is reached

Price Level

RNO

LRAS

Yfc

SRASAD3

Y3

AD4P3

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)

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

The Keynesian non-linear SRAS curve

Price Level

RNO

P2

P3

P4

P1

SRAS

AD1

AD2

AD3

AD4

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.

Inward shift of short run aggregate supply

Price Level

Real National Output (Y)

P1

SRAS1

AD1

SRAS2

Y1Y2

P2

Take a quiz to test your understanding!

Tutor2u Economics

Keep up-to-date with economics, resources, quizzes and

worksheets for your economics course.