Short Run Aggregate Supply (SRAS)

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

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Short Run Aggregate Supply (SRAS)

  1. 1. AS Economics Short Run Aggregate Supply AS Economics, Autumn 2013 tutor2u™
  2. 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. 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. 4. Short Run Aggregate Supply Curve Price Level SRAS1 P2 P1 Y1 Y2 Real National Output
  5. 5. Short Run Aggregate Supply Curve Price Level SRAS1 P2 P1 Y1 Y2 Real National Output
  6. 6. Short Run Aggregate Supply Curve Price Level SRAS1 A rise in the price level will cause an expansion of aggregate supply in the economy P2 P1 AD2 AD1 Y1 Y2 Producers are responding to higher prices (driven up by increased demand) Real national output will increase from Y1 to Y2 Real National Output
  7. 7. Some Causes of Shifts in Short Run Aggregate Supply (SRAS) Labour productivity Changes in import prices Wage Costs Prices of raw materials Price of components
  8. 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. 9. External supply shocks World oil and gas prices Import tariffs / quotas Foodstuff prices Energy prices / costs Other mineral prices
  10. 10. Inward Shift in SRAS SRAS2 Price Level SRAS1 P1 Inward shift of SRAS Less output can be supplied at each price level Y2 Y1 RNO
  11. 11. Outward Shift in SRAS SRAS2 Price Level SRAS1 P1 SRAS3 Outward shift of SRAS More output can be supplied at each price level Y2 Y1 Y3 RNO
  12. 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. 13. How might wheat prices affect SRAS? Which industries / sectors use wheat as a key factor input?
  14. 14. Steel prices will also affect SRAS Falling steel prices would reduce supply costs in the construction industry causing SRAS to shift outwards
  15. 15. International commodity prices Commodity prices have been highly volatile in recent years
  16. 16. The Keynesian non-linear SRAS curve SRAS Price Level Between Y1 and Y2, short run aggregate supply is elastic – because there is plenty of spare capacity in the economy P2 AD2 P1 AD1 Y1 Y2 RNO
  17. 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. 18. When SRAS is vertical, capacity is reached LRAS Price Level 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 P3 AD3 SRAS Y3 Yfc RNO
  19. 19. When SRAS is vertical, capacity is reached LRAS Price Level P4 AD4 P3 AD3 SRAS Y3 Yfc RNO
  20. 20. When SRAS is vertical, capacity is reached 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) LRAS Price Level P4 AD4 P3 AD3 SRAS Y3 Yfc RNO
  21. 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. 22. The Keynesian non-linear SRAS curve SRAS Price Level P4 AD4 P3 AD3 P2 AD2 P1 AD1 RNO
  23. 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. 24. Inward shift of short run aggregate supply Price Level SRAS2 SRAS1 P2 P1 AD1 Y2 Y1 Real National Output (Y)
  25. 25. Take a quiz to test your understanding!
  26. 26. Tutor2u Economics Keep up-to-date with economics, resources, quizzes and worksheets for your economics course.

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