3.3 - Short-run Aggregate Supply (SRAS)
Definition of the SRAS curve
The aggregate demand-aggregate supply model is an economic framework that shows how the overall price level and total output in an economy interact. Within this model, the short-run aggregate supply (SRAS) curve plays a key role.
The SRAS curve illustrates the relationship between the price level in an economy and the total quantity of goods and services that firms are willing to supply in the short run. The short run refers to a period where some factors of production, like wages and prices, cannot fully adjust to changes.
Graphing the SRAS curve
The diagram below shows the SRAS curve, with the price level on the vertical axis and real GDP on the horizontal axis. It slopes upward from left to right: at the lower price level PL1 firms supply Y1, and at the higher price level PL2 they supply the larger output Y2. Moving between those two points is a movement along SRAS, because only the price level has changed.
Reasons for the upward slope of the SRAS curve
The SRAS curve slopes upward, meaning that as the price level rises, the quantity of goods and services supplied also increases. This positive relationship occurs because higher prices encourage firms to produce more in the short run.
Sticky wages and prices
The main reason for this slope is sticky wages and prices. Sticky wages and prices refer to the idea that wages (payments to workers) and some input prices do not adjust immediately to changes in the economy.
How sticky wages and prices create the upward slope:
- When the overall price level rises, firms can sell their products at higher prices, increasing their revenues.
- However, if wages and other costs remain fixed (sticky) in the short run, firms' profits increase, motivating them to expand production and supply more output.
As a result, a higher price level leads to greater output supplied, creating the upward slope.
Determinants that shift the SRAS curve
Certain factors can cause the entire SRAS curve to shift, changing the quantity supplied at every price level. These shifts occur when production costs change across the economy.
Factors causing shifts in the SRAS curve
- Changes in production costs - Any increase in costs, such as higher raw material prices or wages, shifts the SRAS curve leftward (decreasing supply). A decrease in costs shifts it rightward (increasing supply).
- Inflationary expectations - If people expect higher inflation (a general rise in prices over time), firms may raise prices and wages, shifting the SRAS curve leftward. Lower expectations can shift it rightward.
Effects of shifts on the graph
In the diagram below, short-run aggregate supply starts at SRAS1.
- A rightward shift to SRAS2 means more output is supplied at each price level, often due to lower costs.
- A leftward shift to SRAS3 means less output is supplied at each price level, often due to higher costs.
These shifts affect the economy's overall output and price level when interacting with aggregate demand.
Movement along the SRAS curve
Movement along the SRAS curve happens when the price level changes, leading to adjustments in output without shifting the curve itself. This movement reveals important connections between economic variables.
Relationship to price level and output
As the economy moves up along the SRAS curve:
- An increase in the price level leads to higher output, as firms respond to greater profitability by producing more.
- A decrease in the price level leads to lower output, as reduced revenues discourage production.
Connection to inflation and unemployment
Inflation occurs when the price level rises persistently. Movement along the SRAS curve shows a short-run trade-off between inflation and unemployment (the percentage of the labor force without jobs but actively seeking work).
The trade-off between inflation and unemployment:
- When the price level rises (higher inflation), output increases, requiring more employment (hiring of workers). With a fixed labor force (total available workers), unemployment falls.
- When the price level falls (lower inflation), output decreases, leading to less employment and higher unemployment.
This trade-off means policymakers often face choices between controlling inflation and reducing unemployment in the short run.