Download Module 18-SRAS

Module 18- The Short Run
Aggregate Supply Curve
By J.A.SACCO
Short Run Aggregate Supply


1.
2.
3.
4.
The 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
Wages to workers (nominal)
Rent paid to landowners
Interest paid to providers of capital
Prices paid to suppliers of intermediate goods
Short Run Aggregate Supply
Therefore 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.

The Short-Run
Aggregate Supply Curve
SRAS
Price Level
The SRAS slopes upward
because with fixed costs (nominal)
at a higher price level firms make
more profits and desire more output.
120
100
0
1
2
3
4
5
6
Real GDP per Year
($ trillions)
7
8
9
The Shape of the SRAS

Range1 (Flat/Keynesian)
– Input prices (wages,
factors of production)
are constant in nominal
terms. These input
prices cost less than
output of Real GDP.
Revenue > Input Costs
PROFIT
3
2
1
The Shape of the SRAS

Range 2 (Intermediate)
Some input costs
beginning to rise due to
scarcity. Input costs
catching up to revenue.
Beginning to reach
maximum output.
3
2
1
Input Costs catching up to Revenue!
Profits decreasing!
The Shape of the SRAS
Range 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!!

3
2
1
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
Then
Firms 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 Run
LRAS

How can you
produce
temporarily
beyond LRAS?
Why Can Output Be Expanded in the
Short Run?

1.
2.
3.

1.
Use Labor More Intensively
Have workers work harder by increasing the length of
the work and the number of days worked
Switch workers from uncounted production to counted
production that generates output
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 Intensively
Machines can be worked longer, faster, and maintenance
delayed to reduce down time.
Why Can Output Be Expanded in
the Short Run?

Employ More Workers
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 upward
1.

1.
2.
3.
4.
When Capacity is Reached
Workers become less willing to work longer
Machines break down and must be repaired
It becomes harder to find workers at the existing (nominal
wage) as scarcity sets in.
Eventually your input costs rises, because of scarcity, in
proportion to the price level. No more profit.
Non-Price Level Determinants of
Aggregate Supply
Changes That Cause an
Increase (Shift) in Aggregate Supply
A reduction in input prices/decrease in nominal wage
Discoveries of new raw materials
Increased competition
A reduction in international trade barriers
Fewer regulatory impediments to business
An increase in labor supplied
Increased training and education
A decrease in marginal tax rates
A temporary change will shift only the SRAS,
a permanent change will shift both the SRAS and the LRAS!
Shifts in SRAS Only
LRAS1
SRAS2
Price Level
SRAS1
0
1
2
3
4
5
6
Real GDP per Year
($ trillions)
13
7
8
9
Non- Price Level Determinants of
Aggregate Supply
Changes That Cause a
Decrease (Shift) in Aggregate Supply
An increase in input prices/increase in nominal wage
Depletion of raw materials
Decreased competition
An increase in international trade barriers
More regulatory impediments to business
An decrease in labor supplied
Decreased training and education
An increase in marginal tax rates
14
Shifts in SRAS Only
LRAS1
SRAS2
Price Level
SRAS1
0
1
2
3
4
5
6
Real GDP per Year
($ trillions)
15
7
8
9
Shifts in Both Short-and
Long-Run Aggregate Supply
LRAS1
LRAS2
SRAS1
SRAS2
Price Level
Any permanent change in
a factor of production
will shift both
short- and long-run
aggregate supply.
0
1
2
3
4
5
6
Real GDP per Year
($ trillions)
16
7
8
9