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