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Chapter 42: Aggregate supply (2.2)
Key concepts
 Aggregate supply (AS) and output
 The upward sloping AS curve – short run aggregate supply (SRAS)
 Shifts in SRAS
The meaning of
aggregate supply

•
Describe the term aggregate supply
•
Explain, using a diagram, why the short run aggregate supply curve
(SRAS curve) is upward sloping
•
Explain, using a diagram, how the AS curve in the short run (SRAS)
can shift due to factors including changes in resource prices,
changes in business taxes and subsidies and supply shocks
Aggregate supply (AS) and output
Definition: Aggregate supply
Aggregate supply is the planned output of goods and services in an economy during a
period of time at different price levels. There is positive correlation between the price
level and aggregate supply. (Note that we assume that factor prices remain unchanged
along the AS curve.)

The upward sloping AS curve – short run aggregate supply (SRAS)
This is portrayed in figure 3.3.2 as the upward-sloping portion of the short run aggregate supply
(SRAS) curve. The aggregate supply of an economy in the short run is based on the notion of
fixed factor prices and availability – e.g. the constraints are similar to those used in Chapter 4,
that is to say, that all else remains constant – the ceteris paribus assumption.
Figure: 3.3.2 Short run aggregate supply (SRAS)
Price level (GDP deflator, 1995 = 100))
Warning! Factor
prices do NOT change in
moving along the SRAS.
Cork
Bottle
SRAS
115
110
105
100
E
D
C
B
A
80
85
90
95
Physical limit
GDPreal/t (billions 2005 EUROs)
HL; What holds true for a single firm will in this particular
case hold true for the aggregate, namely that increased output
will result in higher marginal costs – the sum of MC curves
for individual firms will give us the SRAS curve for the
economy as a whole. This helps explain the relatively high
elasticity of aggregate supply in the short run.

 Higher market prices will induce
suppliers to increase output. The AS
curve is drawn under the assumption
that prices of factor inputs do not
change in the short run, so a higher
price level means larger profit
margins for firms. Thus the price
level and output are positively
correlated.
 The upward slope of AS also shows
how firms experience diminishing
returns (as existing fixed factors are
ever increasingly utilised) and
increasing scarcity of variable
factors. Both serve to create
bottlenecks in production. (Shown
by the shadowed bottle in the
figure.)
 When it becomes impossible to
increase output in the short run, the
physical limit of the economy’s
capacity is reached and real GDP is
no longer correlated to the price
level. An increase in the price level
simply means a general rise in prices
without any increase in output.
(Shown by the “corked” portion of
the SRAS curve.)
Shifts in SRAS
The short run aggregate supply curve in the AS-AD model will shift when production costs for
firms change. Three specific short run influences can be identified:
1.
Price of labour: An increase in wage rates will mean higher production costs for firms and
shift the short run aggregate supply curve to the left, from SRAS0 to SRAS2 in figure
3.4.11 below. This will result in lower output, Y2, and a higher price level, P2. A decrease
in the wage rate will naturally have the opposite effect.
2.
Price of inputs: Changes in other factor markets, e.g. the markets for raw material, capital
and components will have effects on the cost picture of industrial firms. For example, a
decrease in the price of steel will enable producers of cars, houses and washing machines
etc to increase output at all price levels. This is shown by a shift in short run aggregate
supply from SRAS0 to SRAS1, increasing output to Y1 and lowering the price level to P1.
3.
Taxation and legislation: There are a variety of taxes levied on production which increase
costs for firms. Labour taxes (a percentage on wages paid by employers which go to social
security contributions, pensions and such) add to overall labour costs. Profit taxes (or
corporate taxes) deny firms money that could be used for investment. Environmental taxes
on emissions add to firms’ costs. Legislation on minimum wage rates; overtime regulation;
work hours etc also add to the total cost picture of firms. Increased taxes on labour etc and
stricter regulatory legislation will shift short run aggregate supply to the left, from SRAS0
to SRAS2, while lower taxes and looser legislation will shift the short run aggregate supply
curve to the right, from SRAS0 to SRAS1.
Figure: 3.4.11 Increase and decrease in short run aggregate supply
Price
level
SRAS
2
P2
SRAS
0
P0
P1
SRAS will shift primarily due to
changes in the price of factors
and legislation on taxes and
labour.
SRAS
1
AD0
Y2 Y0 Y1 GDPreal/t
In addition to factors affecting the price and availability of factors of production, there are factors
such as the efficiency of factors and external shocks. Improvements in technology, labour and
production methods will increase aggregate supply while severe storms and/or natural disasters
can decrease aggregate supply.
Summary and revision (need a cool pic here….maybe a pic of someone doing pushups!)
1. Aggregate supply is the planned output of goods and services in an economy
during a period of time. The short run aggregate supply curve is shows positive
correlation between the price level and planned output.
2. A key assumption of the SRAS curve is that factor prices and factor availability
are considered constant. Any change in these variables will shift the SRAS curve.
3. Shifts in short run aggregate supply are primarily caused by the price,
availability, efficiency and quantity of factors of production. Short run aggregate
supply shifts due to:
a. changes in factor prices (wages, raw material, capital)
b. changes in factor efficiency (new technology, production methods)
c. taxation (profit taxes, labour taxes, environmental taxes)
d. government regulations (overtime regulation, subsidies)
e. external shocks (natural disasters, weather)