4.2.2.B - Short-Run Aggregate Supply (SRAS)

Aggregate Supply

The total value of goods and services producers are willing and able to supply at various average price levels in an economy over a given period of time.

Why SRAS is Upward Sloping

- Profits - At a higher price level, suppliers can & are more incentivized to produce more

- Survival - At a higher price level, less efficient suppliers can still break-even and make profit to survive --> produce more

Price Elasticity of Supply (PES)

The responsiveness of quantity supplied in response to a change in the price of a product

Why PES changes (decreases) for different combinations of output & price level?

As capacity utilisation increases, the aggregate supply curve becomes increasingly inelastic.

- Diminishing returns on production - As get near productive potential --> need to use less efficient inputs --> unit cost of production rises --> higher price level required to make a profit --> more inelastic

- Scarce resources - As get near productive potential, factors of production (CELL) become more scarce --> unit cost of production rises --> higher price level required to make a profit --> more inelastic

- Productive potential constraint - Ultimately, production cannot go much beyond the LRAS, therefore the SRAS curve will become vertical shortly after productive potential

Why is SRAS elastic when output is low?

When output is low, unemployment is likely HIGH, because firms do not need workers to produce the low levels of goods and services. As a result, employment decreases which in turn increases the level of unemployment within the economy.

This means that the economy can supply more products without the price level rising (perfectly elastic)

Causes of SRAS Shifts

"It's all about Costs of Production"

- Raw material costs

- Unit Labour Costs

- Indirect Taxes

- Regulations (e.g. Health & Safety trainings)

- Subsidies

- Technical Progress

Chain of Logic - Government reduces level of subsidies

A subsidy is a payment by the government to firms to encourage production. Reduced subsidies --> less funds provided to firms --> higher costs of production --> suppliers less willing & able to supply at any given price-level --> SRAS shifts left

Current Account Deficit

When a country imports more than it exports

Inflationary Pressures

When demand for a good is higher than supply, creating pressure for prices to rise

Negative Output Gap (NOG)

Difference between LRAS and Output/Real GDP (y)

Short Run Economic Growth

Rise in Real GDP