Short Run Aggregate Supply

Short-run aggregate supply (SRAS) is a concept that represents the totality of the goods and services supplied in an economy at a particular price. This macroeconomic concept helps determine the state of the economy and is affected by different factors called determinants, such as labor productivity, prices, government rules, subsidies, and taxes.

SRAS is represented by an aggregate supply curve representing the relationship between price and quantity companies are prepared to supply. Usually, aggregate supply and prices share a positive relationship. They are calculated over a year as the shift in supply takes time to affect product demand.

• Short-run aggregate supply represents the correlation between the economy's total output at a particular price. It is an indicator of the adjustments the economy makes in the event of changes.
• It is usually an upward-sloping curve as the relationship between price increases is directly proportional to the rise in output levels.
• Changes in government policies, wages, skill sets of the workforce, technological advancements, procurement of raw materials, etc., affect the SRAS curve.
• An increase in price levels can indicate to investors and economists that the economy is on a positive growth path.

SRAS helps determine if the economy has been performing at its fullest potential and how external factors like price stickiness and wages can affect the GDP in the short run.

Price stickiness is a situation where factors do not adapt or adjust quickly when exposed to changes. For example, if the wages adjust slowly to the changes in the economy, they are referred to as sticky wages by economists. Sticky wages and prices are apparent; it most often means that the economy might not perform at its optimum output level.

The SRAS curve helps investors and economists understand how the collective of all firms in the economy respond to price stickiness. Therefore, when the prices are sticky, the short run aggregate supply graph shall show an upward-sloping curve, meaning that a higher price level will elicit more economic output.

A couple of things that should be kept in mind while interpreting SRAS are that it represents the short-run correlation between the price level and supply output. Aggregate supply shows an upward slope in the short run as at least one price exhibits inflexibility. Secondly, one can understand the relationship between short-run aggregate supply and inflation with exposure to unemployment. More output can be evident with higher inflation and is linked with lesser unemployment.

The short run aggregate supply graph can experience a shift due to various factors, such as changes in government policies, cost of production, wage hikes, size of the workforce, and changes in inflation rates. While some factors attribute to a positive shift, some account for the negative effect on the curve.

For example, if the short-run prices decrease or the producers or manufacturers think they will decrease, the SRAS will increase. Hence, the correlation between the two is inversely barring the cases with exceptions.

Let us understand the immediate short run aggregate supply curve factors mentioned above in brief through the points below:

#1 - Workforce Productivity

The workforce's productivity and other factors involved in the production process can increase the aggregate supply in the short run. The increase is possible as a higher level of productivity signifies the quality of work, and production efficiency can significantly decrease production costs.

#2 - Wages

A shift in wages increases the cost of production and can crucially affect the quantity produced. Therefore, a higher wage cost ripple effect on the economy as lesser goods are produced as labor wages account for a significant hike in production costs.

#3 - Raw Materials

The cost of materials and other input costs hikes the per unit cost of the products and services, eliciting significantly lesser aggregate supply in the economy.

#4 - Government Policies

The cost of taxes, charges, and regulatory expenditures can present an uphill task for producers and manufacturers to cut production costs. If the taxes and other fees are high, the aggregate supply of the economy tends to be lower.

The formula for the calculation of SRAS is as follows:

Y = Y* + α (P- PE)

Here,

Y = Total production of the economy

Y* = Natural level of production (Always positive)

P = Price

PE= Price expected.

Let us understand the ebbs and flows of this concept of immediate short run aggregate supply curve better through the examples below:

Example #1

Elite Manufacturers Limited produces windshields for leading automobile companies. They produce 100,000 windshields every quarter, costing $1 Million for production.

Their primary raw materials- Limestone and silica ash account for 10% of the overall cost. The prices doubled for these materials in the last quarter due to a shortage in supply and import restrictions.

They could produce only roughly 91,000 windshields while still spending $1 million for the cost of production that quarter. In this case, the decrease in quantity produced shows a dip in aggregate supply.

A dip in supply shall have ripple effects in the form of a hike in demand and subsequently can result in increased prices.

Example #2

In 2020, when the Coronavirus induced lockdowns were announced almost in every country across the globe, the short-run aggregate supply and demand went haywire owing to the panic among buyers and the uncertainty that loomed across all types of businesses.

Since strict restrictions on the movement of people and goods were in place, companies could not produce, which caused a significant shortage in supply in the short run. According to the Board of Governors of the Federal Reserve System, this was one of the factors that caused a severe increase in the inflation rate to a mammoth 6% in the U.S.

Eventually, when the government eased restrictions, manufacturers could produce and cover up for the market demand, the economic revival was underway, and the economy was back on the path toward normalcy.

The SRAS curve represents that an increase in price levels can positively affect an economy's real GDP, showing a positive movement of the economy.

Let us understand the concept with the help of the graph below:

The graph below shows that the price rises from P1 to P2 shifting the SRAS curve leftward. The shift occurs because the price rise typically means higher profits, which implies higher output levels.

Let us understand the concept in detail. Normally, the supply curve in any market model is upward sloping, which is motivated by the profit earning mentality of the firms. Therefore, the moment price of goods increase, the firms will try to sell in higher quantity so as to earn more profit. Here, we see that along with price, the supply also increases. Since in the short run, certain factors like heavy plant and machinery or capital available cannot be changed so quickly, the firm tries to earn profit by increasing the output to take advantage of rise in prices.

Now let us identify the reasons and determinants of short run aggregate supply that may cause a shift in it. Ideally any factor that may cause the production cost to change or the expected profitability to change, will cause the curve to shift. Some of these factors include the following:

• Price of natural resources and other input prices – Lower input prices will reduce production cost, leading to rise in production and output. This will result in rightward shift in the sras curve. Similarly a higher price of inputs will cause the opposite effect.
• The wages of laborers – Wage occupies the cost of a component to a larger extent for the firm. Therefore, its increase will lead to instant rise in production cost and there will be fall in supply and the sras curve will shift leftwards. On the contrary, fall in wage will shift the curve to the right.
• Expectation of future prices of outputs and the rise in total prices – The expectation about the future will have a great impact on how the company handles its production as an important determinants of short run aggregate supply. If expectation is high, the production will increase, to take advantage of price rise. The opposite will happen if the expectation is negative. Thus, an optimistic idea will shift the curve to the right and a pessimistic idea will shift it to the left. However, it is a temporary situation, because here again, the cost of inventory storage comes in. If that is very high, even an optimisic ideas about the future will not change the production.
• The exchange rates – Any change in the prices of goods imported and used in production will affect the production cost and supply and cause a decrease or increase in short run aggregate supply.
• Taxes and subsidies of firms – High tax and lower subsidy will help in bringing down the production cost and shift SRAS curve to the left. If the tax is less and government subsidy provided is more, it will shift the curve to the right because it is bring down the production cost.

Thus, will see from the above how different factors can a decrease or increase in short run aggregate supply by influencing the cost of producing goods and service.

The above are two concepts in macroeconomics that are frequently used to plan production and sales of firms. They are related to each other in many ways, but also has some differences. Let us identify them.

• The former shows what is the level of supply that is possible by a firms at different price levels in the short run, whereas the latter represents the supply in the long run, when the prices, and other resources have already adjusted to the change.
• In case of the former, the supply depends on wage, prices, productivity and policies which cannot change immediately. But in case of the latter, since many factors already adjust themselves, the labor force, technology and capital influence them.
• The SRAS curve slopes upwards, which means as price rises, the firm increases the supply, but the LRAS curve ideally remains vertical since it is not influenced by the prices.
• The former is affected by changes in prices and demand, but the latter is affected by external factors like oil price, technological change and change in wages.

Thus, the above are some important differences between the two whose clear understanding is critical in order to interpret market conditions and plan production and supply in a way that will positively affect the company and market at large.

This article has been a guide to what is Short-Run Aggregate Supply. We explain the curve. its differences with long run aggregate supply & what causes the shift. You can learn more about it from the following articles –

• Recessionary Gap
• Full Employment
• Monetary Transmission Mechanism