Module 18- The Short Run Aggregate Supply Curve

By J.A.SACCO

Short Run Aggregate SupplyThe Short Run is the period that begins

immediately after an increase in the price level and ends when input prices have increased in the same proportion to the increase in the price level.

Input prices are the fees paid to providers of input goods/services

1. Wages to workers (nominal)2. Rent paid to landowners3. Interest paid to providers of capital4. Prices paid to suppliers of intermediate

goods

Short Run Aggregate SupplyTherefore the SRAS represents the

relationship between the price level and the real output of goods/services in the economy without full adjustment and without full information (nominal values not real values).

The SRAS will be drawn under the assumption that all determinants of supply other than the price level will be held constant.

SRAS

The Short-RunAggregate Supply Curve

Pri

ce L

evel

Real GDP per Year($ trillions)

The SRAS slopes upwardbecause with fixed costs (nominal)at a higher price level firms makemore profits and desire more output.

120

0 1 2 3 4 5 6 7 8 9

100

The Shape of the SRASRange1

(Flat/Keynesian) – Input prices (wages, factors of production) are constant in nominal terms. These input prices cost less than output of Real GDP.

1

2

3

Revenue>Input Costs

PROFIT

The Shape of the SRASRange 2

(Intermediate) Some input costs beginning to rise due to scarcity. Input costs catching up to revenue. Beginning to reach maximum output.

1

2

3

Input Costs catching up to Revenue!

Profits decreasing!

The Shape of the SRASRange 3

(Classical/Vertical) Input costs are now equal to revenue. Input costs are in proportion to the price level. No incentive for producers to supply more. No more profit!!

1

2

3

As you move along the SRAS, the lagtime between input costs and profits becomes shorter and shorter until input costs equals revenue.NO PROFIT!!

Short Run Aggregate Supply

Therefore, what is held constant are prices of inputs (nominal) used in the production of all goods and services.

If the price of inputs are constant (nominal)

And the price level rises

ThenFirms will expand supply and make a profit

Furthermore, in the short run, if the price level rises, output can expand temporarily even beyond (LRAS) the economist’s notion of the normal capacity of a firm and thus the entire economy.

Producing Beyond the Long Run in the Short RunHow can you

produce temporarily beyond LRAS?

LRAS

Why Can Output Be Expanded in the Short Run?Use Labor More Intensively1. Have workers work harder by increasing the length

of the work and the number of days worked2. Switch workers from uncounted production to

counted production that generates output3. With labor being paid in nominal wages based on

yearly contracts, employers are paying less in wages than the increase in the price level. The nominal wage does not keep up to inflation (real wage). A lagtime exists.

Use Capital More Intensively1. Machines can be worked longer, faster, and

maintenance delayed to reduce down time.

Why Can Output Be Expanded in the Short Run?Employ More Workers1. As profits increase, producers hire more workers,

unemployment rate falls and people begin to enter the labor force

Increased production can not go on forever even if the price level rises which is why the SRAS begins to slope upwardWhen Capacity is Reached1. Workers become less willing to work longer2. Machines break down and must be repaired3. It becomes harder to find workers at the existing

(nominal wage) as scarcity sets in.4. Eventually your input costs rises, because of scarcity,

in proportion to the price level. No more profit.

Non-Price Level Determinants ofAggregate Supply

Changes That Cause anIncrease (Shift) in Aggregate Supply

A reduction in input prices/decrease in nominal wageDiscoveries of new raw materialsIncreased competitionA reduction in international trade barriersFewer regulatory impediments to businessAn increase in labor suppliedIncreased training and educationA decrease in marginal tax rates

A temporary change will shift only the SRAS,a permanent change will shift both the SRAS and the LRAS!

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SRAS2

Shifts in SRAS OnlyPri

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evel

Real GDP per Year($ trillions)

0 1 2 3 4 5 6 7 8 9

LRAS1 SRAS1

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Non- Price Level Determinants ofAggregate Supply

Changes That Cause aDecrease (Shift) in Aggregate Supply

An increase in input prices/increase in nominal wageDepletion of raw materialsDecreased competitionAn increase in international trade barriersMore regulatory impediments to businessAn decrease in labor suppliedDecreased training and educationAn increase in marginal tax rates

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SRAS1

Shifts in SRAS OnlyPri

ce L

evel

Real GDP per Year($ trillions)

0 1 2 3 4 5 6 7 8 9

LRAS1SRAS2

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SRAS1

Any permanent change in a factor of productionwill shift bothshort- and long-runaggregate supply.

Shifts in Both Short-andLong-Run Aggregate Supply

Pri

ce L

evel

Real GDP per Year($ trillions)

0 1 2 3 4 5 6 7 8 9

LRAS1

SRAS2

LRAS2